“Pretty High Land” - Byron King

by Byron King

I told you last week that I have come up to Alaska to participate in a geological field trip, looking at the rocks, minerals, and energy resources of the 49th state from the Kenai Peninsula in the south to Prudhoe Bay and the Arctic Ocean in the north. I have just completed the majority of the trip, and was able to fly down to relatively balmy Fairbanks from very chilly Deadhorse. So now, dear readers, I can take some time to reflect and write to you.

Thrilling and Humbling

On a personal level, I am both thrilled and humbled by my trek across Alaska. In many respects, I am awestruck. And I am privileged, if not blessed, to have been part of the endeavor. I was in the company of a group of astonishingly smart and gifted geologists, supplemented by a number of subscribers to Whiskey & Gunpowder who answered the call of a note that I put out in March. The Whiskey readers were outstanding participants and overall super troopers, as one would expect of such a hardy breed. And the geologists on the transect included the famous Gil Mull, one of the original Richfield Oil (later, ARCO) team that discovered the 15-billion-barrel Prudhoe Bay oil field in 1967. As you can imagine, the discussions of geology and, in particular, the oil and gas potential of Alaska were… well, they were pretty deep. (OK, sorry for the pun.) We “went there,” if you know what I mean. And once you go there, perhaps, I think that you can never really come all the way back. There is just so much to say, dear readers. Where to begin?

Mountains and Pipelines

Let me begin at the beginning and go back to Aug. 21, 1778, when the redoubtable British sea Capt. James Cook was sailing north through what would later be named the Chukchi Sea. Cook had, in fact, sailed farther north than even the most daring Russian navigators of that era or previous times. He went into a region inhabited by the relatively nomadic, but also relatively friendly and industrious Native Alaskan people who eked a living from the sparse fruits of a cold sea. Cook gazed at one distant body of land and wrote in the ship’s log about a place that “appeared to be pretty high land, even down to the sea.” Cook also noted, of interest, that it was “destitute of wood.” Cook called the place Cape Lisburne, after a British earl of that same name. Cape Lisburne is the westernmost extremity of what is now called the Brooks Range.

And what a range of mountains is that Brooks Range! It is a rugged, jagged, foaming ocean of snowcapped mountains, 150 miles wide and 750 miles long, extending from the northwest coastline of Alaska far to the east and deep into the Canadian Yukon. The Brooks Range is larger in many respects than the Appalachians, yet in my experience, few have even heard of this massive geological feature. The Brooks Range, so named in the 1920s after a brilliant and bold geologist who pioneered the exploration of the mountain system, boasts peaks of 10,000 feet in elevation, and lies entirely above the Arctic Circle. Much of it lies within the protective jurisdiction of the Gates of the Arctic National Park and the Arctic National Wildlife Refuge (ANWR). The Brooks Range is the northernmost range of mountains in the world, geographically isolating a very flat coastal plain the size of California that is called the North Slope of Alaska.

Earlier in the 20th century, many geologists thought that the Brooks Range was an extension of the U.S. Rocky Mountains and their northerly companion, the Canadian Rockies. But now, in an era when plate tectonics is the operative geological paradigm, it appears that the Brooks Range is its own Arctic mountain system, sui generis, and filled with thrust-faulted masses of sedimentary rocks that are, in turn, closely related in time, space, and tectonic force to the opening of the Arctic Ocean Basin due to sea-floor spreading. And because of this interesting scientific tidbit, the Brooks Range and North Slope offers an entirely different sort of petroleum and natural gas system than one might initially expect when using “lower 48” forms of geological thinking. Hold that thought, dear readers.

I will discuss more geology in this and, of course, future articles. But I also want to get you thinking about the fact that the Trans-Alaska Pipeline System (TAPS) -- in particular, the famous Alaska Pipeline -- has to cross the mighty Brooks Range as part of the first leg of its route south from Prudhoe Bay, about 500 miles east of Cape Lisburne. Thus, in the first push for the petroleum of the North Slope, immense pumps the size of several railroad locomotives connected together in a series drive the oil from sea level to up and over the aforementioned Brooks Range, along a “utility corridor” established by federal law for just that purpose. Currently, the oil pushed through and making the ride amounts to about 800,000 barrels per day, although in earlier years the North Slope was producing, and the Alaska Pipeline was transporting in excess of 2.2 million barrels per day. (The decline is due to reservoir depletion.) Think of just the energy required in overcoming the force of gravity, in order to lift that much oil high enough to cross a broad, high mountain range. Hold that thought, too.

TAPS crosses the Brooks Range at Atigun Pass, a narrow crack in one particular mountain composed of mostly solid quartzite conglomerate. Atigun Pass is about 170 miles south of Prudhoe Bay and sea level, offering one of the only clear shots to the south, albeit over a glacially carved valley and at an elevation more than 4,800 feet above sea level. Atigun Pass is, they say, utterly treacherous in wintertime, which is most of the time up here. And the Brooks Range is just one of three immense mountain ranges, and nearly 1,000 rivers and streams, that the Alaska Pipeline crosses in its long 800-mile path to Valdez on the southern coastline of Alaska. Hold that thought as well.

Putting Thoughts Together

OK, dear readers, I asked you to hold some thoughts and now it is time to put some of these thoughts together from the perspective of Outstanding Investments. [Greg’s Note: Outstanding Investments is the best performing stock research newsletter in the world over the past five years. Go here to subscribe.]

Hydrocarbon-Bearing Formations

One of the oil-bearing and -producing formations at Prudhoe Bay is called the “Lisburne limestone.” Does that name sound familiar? It should, because it is related in time and origins to the rocks that form Capt. Cook’s so-named Cape Lisburne, many hundreds of miles to the east. And there are many other hydrocarbon-bearing rock formations that the good Capt. Cook never saw or suspected, currently productive or otherwise prospective, north of the Brooks Range. These rock formations are deeply buried under the North Slope, and extend from under the Chukchi Sea, along the northern coastline of Alaska and offshore, following the line of the Arctic Ocean all the way over into northern Canada. Also of exploration interest, somewhere in northern Canada, according to some geologists, lies the “other half” of the Arctic Basin rift system, where there may be rock units similar to what we find beneath the North Slope. So there is immense hydrocarbon potential along the North Slope, and perhaps elsewhere in the northern region of North America.

Isolated, Vast, Cold

Yet despite the rich prospective hydrocarbon potential of this vast Arctic area, it is immensely difficult to accomplish even the most basic of tasks. The place is almost entirely uninhabited and there are simply no roads or other infrastructure. Ingress and egress is by dog sled in winter, airlift most other times (except when the winds are blowing 150 miles per hour), or barge during the few ice-free months of summer. Most everything else currently arrives in Deadhorse, Alaska, after a 420-mile trip up the 20-foot-wide gravel “Haul Road” (now named the Dalton Highway) that parallels the Alaska Pipeline from Fairbanks to Prudhoe Bay. My group of touring geologists rode up that rough road in a set of tough vans, viewing (and feeling) every hard mile of Haul Road, and observing the Pipeline in all its industrial glory, which is significant.

Climate is, as one would expect so far north of the Arctic Circle, constantly extreme and from an environmental standpoint extremely fragile. As Capt. Cook noted, the area is “destitute of wood.” Yes, indeed, and it is destitute of almost everything else under God’s sun. In fact, for many months of the year, it is destitute of even the sun. And it is cold, too. It is very cold, my friends. When I stood at the edge of the Arctic Sea the other day, a sunny day in June, with my boots just touching the ice-clogged waters, the temperature was nominally in the low 30s Fahrenheit. But I think that somebody was lying. It had to be colder than that, or perhaps it was the 40-knot gusts of wind that cut through and penetrated a U.S. Navy-issue Gore-Tex Arctic outer liner, plus numerous other layers of protective clothing. There is something about the Arctic wind that just wants to kill you, and for a deeper understanding of that, I recommend any of a number of poems by the great Robert Service. But the point is: Wow, was it ever cold!

When you find something in that frozen north (and if you look hard, dear readers, you probably will), what do you do with it? How much is there? What are the numbers on any given prospect? What are the economics? What is the environmental impact? How do you plan for large-scale industrial development in such a remote and harsh environment? What are the logistic challenges, the hurdles, the utter barriers (such as crossing Gates of the Arctic National Park lands or ANWR) to accomplishing what you want to do? How do you arrange for long-term extraction operations, and transport your treasure to the eager markets of the world? These are just the first of many hard and exceedingly expensive questions you have to ask.

One of the World’s Great Oil Finds

I mentioned earlier that geologist Gil Mull, who was part of the original exploration team that found the Prudhoe Bay field in 1967, was on the trip to the north. Gil described the early days of exploring around Prudhoe Bay in the mid-1960s, when the oil workers would take off in a transport aircraft from Fairbanks and fly north to an utterly isolated drill site on the edge of the frozen Arctic Ocean. This was, of course, before the Haul Road, the Pipeline or anything else even remotely resembling the current state of development after 40 years. There was no global positioning system (GPS) in those days, and not even any of the radio navigation aids that were then around and available farther south but not working so far north. All they had to steer by was dead reckoning, aiming the nose of the airplane eventually at the glowing light on top of the drilling rig. Little rig, big Arctic. And once they saw the light, they would land the airplane, in the dark, on an ice runway carved out of frozen tundra. Any volunteers?

To give away the happy ending of the story of the first well in the Prudhoe Bay area, the “discovery well” of one of the world’s great oil finds, they drilled into a 300-foot gas cap at the top of a deeply buried structure, underlain by dozens of feet of oil-soaked sandstones and conglomerate. Many months later, when they drilled the confirmation well about seven miles away on the flank of the structure, they found over 400 feet of oil column in the rocks. Gil discussed how, during one coring operation, they started to pull the core out of the drilling tube and “it simply flowed out, just sand and rock and oil, 180 degrees or so hot, flowing and steaming all over the drilling deck.” At one point, the geologists conducted what is called a “drill stem test,” in which they allowed the fluids from the well simply to flow into the drill pipe. “We rapidly had a supercritical pressure buildup,” said Gil. “And then we closed off the drill stem mechanism and it took over 12 hours simply to blow down the pressure. We were flaring natural gas for 12 hours just to get the high pressure down.”

Yes, Gil was fortunate enough to have been part of a group that found the largest oil field ever discovered in the U.S. or Canada, 10 billion barrels, or so they thought at the time (now we know that it is much larger, near 15 billion barrels). But the Prudhoe Bay field got developed only because it was so large. Anything much smaller might not have paid off, because there was no other infrastructure. The next step was to build the Haul Road and adjacent Alaska Pipeline, which ultimately took an act of Congress and a total of $11 billion in 1970s-era dollars.

Could we do something similar today? And we have to ask, would it be worth it to do so? Because, dear readers, whatever happens is going to cost, and cost really big, and I mean that in many respects. This is spectacular territory, but it is spectacularly fragile and treacherous as well. As Barry Lopez wrote in his book Arctic Dreams, “No summer is long enough to take away the winter. The winter always comes.” To my observation, winter never really leaves.

Think of this in terms of current and future exploration to the far west of Prudhoe Bay, in what is quaintly labeled on the pretty maps as the “National Petroleum Reserve-Alaska.” Yeah, right. “Petroleum Reserve.” Piece of cake, huh? Who is going to develop that “petroleum reserve”? Who will pay to drill it up, and to build the next part of the Arctic energy complex? Who will take the risks, and make a series of large hydrocarbon discoveries, and then build an accompanying “Northern Pipeline” across 500 miles of North Slope and Arctic Ocean coastline? Will anyone venture to build something else down to the south (and if so, to where?) across that all-but-impenetrable Brooks Range of mountains? Think about it. Who is going to do that? Will someone find another Prudhoe Bay and mark out another Atigun Pass, maybe? There is nothing easy about this, nothing at all, not even breathing that cold Arctic air.

Things Are Going to Happen

I will close by saying that I believe strongly that many great and vast and difficult things are going to happen in northern Alaska, and I am going to watch it all like a hawk. But I know, and I am absolutely certain, that whatever happens will have to occur in a harsh and utterly unforgiving Arctic world that is very much different from the world in which our civilization developed its resources in the past. People are, in all likelihood, going to do what has to be done, and spend the funds to accomplish the tasks. But what challenges! And what expenses! And what risks! Fools dare not rush in, and we want to screen those fools out of our Outstanding Investments portfolio. That is why I am discussing so much in this update to you.

Looking at things more broadly, I do not think that, at any time over its entire history, mankind has ever done anything remotely similar in scope to what is going to occur up in the frozen north over the next few generations. As I stated near the beginning of this article, I am simply humbled at the measure of the task. I am awestruck.

Please keep reading this newsletter, dear readers. There is much more to say. But for now, I bid you all adieu.

Until we meet again…
Byron W. King

For Whiskey and Gunpowder

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments.

Offshore Technology Conference Update - Byron King

by Byron King

The Offshore Technology Conference (OTC) 2007 proceeds apace. Are you in the business? What do you need? What do you want to know? It is all here. Pick an item or service.

What Do You Need?

Corrosion and abrasion control? 76 exhibitors. Wellbore equipment? 36 exhibitors. Laboratory equipment? 14 exhibitors. Offshore platforms? 68 exhibitors. Decommissioning services? 33 exhibitors. Mooring and positioning systems? 60 exhibitors. Pumps and compressors? Another 60 exhibitors. Artificial lift? 25 exhibitors. And it goes on. Just the OTC program alone is the size of a small-town telephone directory. Welcome to the world of the offshore, and to the OTC.

From Where Does It All Come?

In other articles, I have asked the question, how far upstream do you think? When you fill the gas tank of your car, do you ever wonder about the fuel-holding systems under the parking lot of the gas station? Do you think about the tanker truck that hauled the fuel from a terminal to the gas station? Do you think about the terminal tanks? How about the interstate pipeline or barge that carried the fuel from the distant refinery to the nearby terminal? Or the pipelines that brought the oil to the refinery? Right about at this point is where the purpose of the OTC begins.

What Is the OTC?

The OTC includes the geophysical services that help the geologists pick a spot in the middle of the ocean, so they can tell management where to spend a billion dollars or more. The OTC includes the drill ships, the jack-up rigs, and the semi-submersibles that will drill the wells. The OTC includes the drill bits, the pipe systems, and casing plans. The OTC includes the down-hole equipment that penetrates six or seven miles into the crust of the Earth. The OTC includes the massive equipment that powers and runs the rigs, the cables, the wires, the electric transmission, the safety systems, and pollution control devices. The OTC includes the transport vessels that haul stuff out to the rig, and other vessels that haul the oil ashore, or the subsea systems that pipe it there. The OTC includes the communications equipment, the training for the workers, the logistics that puts it all together, the insurance, the inspections and quality assurance, the banking, and even the good-old government regulation. The OTC is a reflection of a complex, world-spanning industry.

Rocket Science, Without the Rockets

So the OTC highlights the offshore oil industry, but with an emphasis on things about which you do not usually ponder unless you have been there. Take all of the complexity of drilling for oil and gas onshore. Take all of the geological risk, the political risk, the high costs and financial risk, the environmental risk. Take it all and then put it out in the ocean, up to hundreds of miles from shore, in water (almost always cold water, by the way) up to two miles deep, and constant corrosion and occasional hurricanes, typhoons, or icebergs coming your way. And the dictates of the modern global economy are that whatever you do, you have to do it quickly, efficiently, and safely. It is rocket science, but without the rockets.

History and Trends

The offshore industry has been around for about 60 years or so, ever since people started siting drilling rigs out over the shallow waters of the coastlines of several continents. Quite a bit of what goes on offshore is an evolutionary development of technology, with people identifying challenges and meeting them progressively.

In today’s world, as you can imagine, there are many dedicated programs to provide a boost to that evolutionary process, if not to “force” the process along. These range from government-funded research to university-level programs, and many private industrial and consultative efforts, with all sorts of combinations of the foregoing. It is all about moving farther out from shore, to more prospective areas, to deeper waters, to more extreme climates. It is all about looking for oil and gas, finding it, and bringing it to landfall.

Alternative Energy Sources From Offshore

Well, it was all about looking for oil and gas and bringing it home. This year’s OTC program actually devotes quite a bit of time and effort to offshore wind power development, as well as to capturing energy supply from tidal and wave action. It makes sense. The same people who have been designing structures and bending metal for the offshore hydrocarbon extraction industry for the past six decades are the ones whom you would expect to have the technical expertise to bend metal for energy capture systems in wind and wave.

Matthew Simmons: Energy From the Ocean

Energy derived from the ocean will be a key source of future energy supplies for the United States, said Matthew Simmons, the chairman of Simmons & Co. Intl. and author of the highly regarded book Twilight in the Desert. According to Simmons, who presented his talk to an eager and enthusiastic crowd of OTC attendees, the U.S. industry and government need to begin “now” to conduct aggressive levels of research to develop oceanic energy resources.

“This is the issue we should have paid attention to for the last 15 years,” said Simmons. Simmons noted that offshore oil production has already begun to decline, using as examples the depletion profiles of areas in the Middle East, Mexico, and the North Sea. In January 2007, noted Simmons, global offshore oil production was down 1 million barrels per day (b/d) from May 2005.

Meanwhile, according to Simmons, the offshore rig fleet is becoming “long in the tooth” as rigs age without adequate levels of new construction. Due to skyrocketing construction costs and shortages of yard space and personnel, offshore vessels and rigs are not being replaced as quickly as they should be to maintain the future pace of offshore drilling. Many vessels will also “become obsolete” in the next five-10 years, Simmons said, explaining that contractors have done an “excellent job of refurbishing rigs,” but “rust never stops.”

One key point that Simmons made in his talk was that “To slow the decline in oil and gas production, we must drill faster.” But he warned, “We may be faced with a declining rig fleet.”

Thus, according to Simmons, energy capture from the ocean offers a number of opportunities to develop future energy supplies. These include waves, currents, tides, aqua biofuels, ocean geothermal, and vent and seep energy. In a comment that had many in the room nodding their heads, as if complimenting a great idea, Simmons said, “Algae is the single most interesting biofuel. There is plant life in the oceans far below where light ever strikes.”

Simons also noted that gas hydrates are another potential energy source that remains untapped. “We have never tried to capture them, so we don't know if it would be successful, but at least we have not tried and failed.”

And on that hopeful note, I will end this update from the OTC.

Until we meet again…
Byron W. King

For Whiskey and Gunpowder

Byron King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000 foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the current commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Bakhtiari’s Event of the Century - Byron King

by Byron King

I HAVE RECEIVED more correspondence from Ali Samsam Bakhtiari of Tehran, Iran. I want to bring Dr. Bakhtiari’s important work to the attention of the readers of Whiskey & Gunpowder.

Ali Samsam Bakhtiari

I wrote about Dr. Bakhtiari last August, when Whiskey & Gunpowder published a set of articles that I wrote about his views on Peak Oil. In “Nothing Like Business as Usual,” I explained that Bakhtiari is a retired "senior energy expert," formerly employed by the National Iranian Oil Co. (NIOC) of Tehran, Iran. During his long career with NIOC, between 1971 and his mandatory retirement due to age in 2005, Bakhtiari held a number of important positions of immense trust and responsibility.

At the time he retired, Dr. Bakhtiari was attached to the director's office in the Corporate Planning Directorate of NIOC, specializing in issues related to the global oil, gas, and petrochemical industries. Bakhtiari is now an independent consultant with no official affiliation with NIOC. He spends his time writing and speaking to a worldwide audience on the subject of oil depletion in general, and Peak Oil in particular. Dr. Bakhtiari is far too humble to say it, but of course you may presume that his views on Peak Oil are published in Iran. This helps to understand certain strategic assumptions in the realm of energy that inform the Iranian governing bodies.

“An Era in Which We Know Nothing Much”

Last year, in an address to the senate of Australia, Bakhtiari stated that "I can see a range of $100-150 [per barrel of oil] not very far into the future." He amplified this statement as follows:

"We are entering an era in which we know nothing much, where we have a
brand-new set of rules...One of these new rules, in my opinion, is that there
will be in the very near future nothing like business as usual. In my opinion,
nothing is usual from now on for any of the countries involved. And the lower
you are in the pile, the worse it is going to get."

Four Phases of Decline

Dr. Bakhtiari views the future of worldwide oil extraction in terms of four phases of transition, or, as he puts it, T1, T2, T3, and T4. I described these four phases in greater detail in an article entitled “Peak Oil and Bakhtiari's 4 Phases of Transition.”

In an e-mail to me that explained and amplified his views, Bakhtiari stated:

“The four transition periods (T1, T2, T3, and T4) will roughly span the
2006-2020 era. Each transition [will] cover, on average, three-four years…[T]he
only transition we can see rather clearly (or rather, we hope to be able to
comprehend) is T1. It is clear that T1 will witness the tilting of the 'oil
demand’ and 'oil supply’ scales -- with the former dominant at the onset and the
latter commanding toward the close (say, by 2009 or 2010).”

That is, Bakhtiari's view of T1 is that worldwide oil supplies will remain almost constant during this initial phase. New discoveries and production that is now coming on line will just about compensate for the production that is lost due to depletion. But T2, T3, and T4 will be, as Bakhtiari puts it, "more turbulent phases."

The Peak Has Been Reached

According to Dr. Bakhtiari, the world has now reached and passed the point of Peak Oil. Bakhtiari has recently published an essay entitled “The Century of Roots.” Bakhtiari has reviewed the available evidence on world oil production and believes that world output peaked absolutely in 2006. Here is what he is saying:

“After some 147 years of almost uninterrupted supply growth to a record
output of some 81-82 million barrels/day [mb/d] in the summer of 2006, crude oil
production has since entered its irreversible decline. This exceptional reversal
alters the energy supply equation upon which life on our planet is based. It
will come to place pressure upon the use of all other sources of energy -- be it
natural gas, coal, nuclear power, and all types of sundry renewables, especially
biofuels. It will eventually come to affect everything else under the sun.”

“Everything else under the sun”? That sounds like quite a lot, but Dr. Bakhtiari has done his background work, to include reviewing numerous models for oil extraction on a worldwide basis. In a paper delivered to an oil conference in Italy in March 2007, he concluded that in 2006, overall depletion subtracted about 3.5 mb/d of oil extraction from the daily global total of oil output (plus or minus 10%), and that a maximum of 2.5 mb/d of “new” oil production came on line, which includes new and expanded oil fields, as well as new projects in the Canadian tar sands areas. Thus, according to Bakhtiari, in 2006, depletion was greater, by more than 1 mb/d, than new discoveries and reserve growth, including oil produced from unconventional sources such as the tar sands.

Dr. Bakhtiari’s conclusion, presented to the Italian conference in March, was that “the peak of global oil production has been reached.” Bakhtiari now sees the world entering a phase of irreversible decline in daily oil output, moving down from the current 82mb/d toward daily oil extraction of only 55 mb/d by the year 2020. He discussed this with me in some comments he made last year, as well:

“T1 has a very benign gradient of decline, and it will take months before one
notices it at all. But T2 will be far steeper...My World Oil Production Capacity
model has predicted that over the next 14 years, present global production of 82
million barrels per day will decrease by roughly 32%, down to around 55 million
barrels per day by the year 2020.”

Event of the Century

Dr. Bakhtiari believes that this state of affairs, the peaking of global oil extraction, is truly the “event of the century,” which he explains thus:

“The 21st century is still young, as there are another 93 years to go. So it
might sound overambitious to claim that 'The Event of the Century’ is already
behind us. But I'll gladly take the risk, for I seriously believe that the
peaking of the global production of crude oil -- commonly know as 'Peak Oil’ --
has occurred in 2006 and will be 'The Event’ bound to dominate the history of
the 21st century: one of those 'historical inflection points,’ which abruptly
change fundamentals in the course of world history. I cannot foresee any other
event coming to eclipse Peak Oil, not even the world wars which might be
unleashed in the Peak's aftermath and further fueled by widespread resource
scarcity. Unless, of course, humanity decides upon collective suicide with the
massive use of weapons of mass destruction; but such an annihilating event would spell the word ‘end’ for most, if not all, of mankind.”

Dr. Bakhtiari believes that almost all of what are considered to be major current trends of humanity will be altered by Peak Oil. Here is what he says about one key trend, the future of population growth:

“Take, for example, population. In the 'Post Peak’ era, population growth
will gradually decrease before becoming stagnant (following crude oil) and
passing a Peak of its own -- my early projections show a 'population peak’
occurring some time around 2025 (a 20-year lag respective to oil) at a global
level of around 7.5-8.0 billion people. There is little doubt that crude oil is
our world's 'master domino’: when it thrives, all other dominoes flourish, and
when it tumbles, it does topple all of the others too. Thus, interestingly,
'Peak Oil’ will not usher in a revolution, but rather an evolution 'en sense
contraire’ ('in reverse gear').”

“Every Nook and Cranny”

Dr. Bakhtiari has this to say about both the future, as well as the nature of mankind:

“Peak Oil', however, is now in the past, and we are presently left facing the 'Post Peak’ era. There is little doubt that in this brand-new period, massive changes are bound to occur. The usage of relatively cheap crude oil has invaded every nook and cranny of our modern world economy -- sometimes without the wasteful invasion being fully realized. Moreover, the ubiquitous oil products have created addictions (especially in the transport sector) which will be extremely difficult to uproot. And not only is the addiction to motorcars common throughout the developed world, it has also begun making deep inroads in China, Russia, and even India: a very dangerous development, indeed, because as American physician and poet Oliver Wendell Holmes [1809-1894] judiciously
remarked:

‘Man's mind, once stretched by a new idea, never regains its
original dimensions’”

Mortal Danger

Dr. Bakhtiari continues on a profound pathway, and I will simply quote him at length:

“In 'Post Peak,’ all of our systems of habits are in mortal danger. Due to
the relative cheapness of crude oil (in relation to other, more expensive daily
needs), people don't exactly realize the pivotal role played by its products in
their daily routines -- as these products have invaded every nook and cranny of
our modern life. It is only when the brakes will be pulled (as they inevitably
will have to be) that the general public will come to gradually realize the
critical importance of 'black gold’ -- which currently provides no less than
two-fifths of world energy -- and of ‘energy’ in general in their living habits.

“Thus, at present, the global masses seem totally unprepared for the two
shocks which will inevitably occur in 'Post Peak.’ On the one hand, no major
institution or medium is willing to inform them seriously on the not-so-palatable consequences of 'Post Peak’; and, on other hand, specialized institutions (such as the International Energy Agency [IEA], the Energy Information Administration [EIA] and OPEC) as well as some major energy consultancies (e.g., the Cambridge Energy Research Associates and the Edinburgh-based Wood Mackenzie research outfit) will go on denying 'Peak Oil’ by issuing rosy future oil output predictions.

“So that the twin shocks are now inevitable on a global scale, as there is no time left to prepare public opinion for 'Post Peak’ sequels. The shocks will first surprise, then jilt, and finally entangle swaths of people worldwide. Those better prepared will be less inclined to react in a disorderly way and panic when the shocking truth will be unveiled.”

Two Main Types of Shock

Dr. Bakhtiari delves into the state of preparation of major nations and populations for what is about to ensue and concludes as follows:

“In the large majority of countries, no one has prepared (or wanted to prepare) the general public to the historical 'Peak Oil’ event and to its momentous consequence in their daily lives. Thus, most probably, the popular masses will be directly exposed to two main types of shock:

A material shock;
A psychological shock.
“Due to the benign decline gradient in crude oil production during the early 'Post Peak’ period -- only 3 mb/d over the first transition period spanning 2007-2010 -- the material shock will not pose insoluble problems and accommodation will prove possible with minimal gradual pain. Moreover, sizeable amounts of wastage in most developed societies will provide a welcome cushion for the initial cuts to be made.

“Not so for the psychological shock. This shock, in stark contrast, will be electric and abrupt. Stress, fear, depression, despairs, and nightmares will be the order of
the day -- as people come to face the not-so-palatable facets of 'Post Peak.’ When confronted with this series of unknowns, with the trauma of change, people will try to protect themselves by automatically reverting to their past, to the known, to what they believe to be "real and true" -- in a word, to their reassuring 'roots'”

The Need to Cope and Adapt

Dr. Bakhtiari has more to say on Peak Oil and the future of mankind, and we will discuss his views in future articles in Whiskey & Gunpowder. But this recent perspective that we are past Peak Oil, based on Dr. Bakhtiari’s analysis of oil data from 2006, is entirely consistent with what he told me last year. In previous correspondence, Dr. Bakhtiari stated to me that the “gradation in decline (between T1, T2, T3, and T4) is a genuine blessing for those having to cope and adapt.”

I noted in my articles last year that, indeed, any gradation that becomes evident, and which leads to an understanding of the dire implications of Peak Oil, is a blessing. But this is so only if informed people and the industrial and political policymakers of the world actually take Peak Oil as a serious matter and set policy accordingly. Will this happen? Is Peak Oil yet a topic of discussion among the high and mighty, as well as a matter of individual and local concern? Hardly, although I believe that Peak Oil is certainly a completely valid investment paradigm. Aside from merely making money, however, there is much more to accomplish, and the time is growing short.

When it comes to his effort to explain Peak Oil to a worldwide audience, Dr. Bakhtiari is a prophet. (A humble prophet, I should add. He is embarrassed when I say such things about him.) But Bakhtiari has both predicted something, and given a 14-year time frame for its occurrence. On this score, he is envisioning the future.

Dr. Bakhtiari’s efforts, his writings, and his work embody the old saying that "Time takes no holiday." Once again, as with my previous articles, allow me to end by expressing my deepest thanks to Dr. Bakhtiari for sharing his thoughts with me and trusting that I will present them to our readership at Whiskey & Gunpowder, and wherever they go from there. Also, once again, I offer the words of the great Dante Alighieri, who wrote in Purgatorio, Canto III, "It is the wisest who grieve most at the loss of time."

Until we meet again...
Byron W. King

For Whiskey and Gunpowder

Byron King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000 foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the current commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Armies of Geologists - Byron King

I HAVE DISCUSSED in previous articles that I attended the recent annual convention of the American Association of Petroleum Geologists (AAPG), held in Long Beach, Calif. It was a gathering of about 5,200 geologists from around the world, and many others who work in related fields dealing with the world’s oil and gas industries. In addition to the formal members of the AAPG, the convention hosted many hundreds more individuals from related industries (such as the oil service companies, geophysics companies, and the like), as well as from government and academia.

One of the things that struck me about the assembled throng was just how collectively well educated the whole group was. I say that in all humility, because a very large number of the AAPG membership holds more and higher levels of academic degrees than I. That is, there are many members of AAPG with one or more master’s degrees in scientific and technical fields. The numbers of Ph.D. holders, combined with the broad spectrum of research fields in evidence, was entirely impressive if things like that impress you. So the point is that the Long Beach Convention Center was just dripping with academic wax and ribbons.

Mr. Wang, Marine Geologist

I had the pleasure of spending some time with a delightful man named Mr. Wang, from an institution called the “University of Geoscience” in Wuhan, China. Mr. Wang is a marine geologist, and teaches the subject at the university level. He is very smart, as I rapidly discerned after we sat down next to each other on a bus, and during a field trip to look at the rocks of the Palos Verdes Peninsula. Mr. Wang and I discussed numerous subjects of a geological nature, subjects of which he has an excellent grasp, in both English and Chinese. Here is some of what we discussed.

I asked Mr. Wang how many students attend the University of Geoscience in Wuhan.

“About 20,000,” he replied.

“You have 20,000 students majoring in geology?” I asked, stunned at the number.

“Oh, no,” he replied with a smile. “Many of our students study in other fields of science, such as physics, chemistry, biology. And we even have a few students who study art and theater.”

No doubt, I thought, the “few” artists and theater majors in a Chinese university are probably the ones who are actually good at it. “So how many people do you have studying geology?” I asked.

“Hmmm…. About 10,000,” he replied.

“10,000? In what fields of geology do the students pursue their studies?” I asked.

Mr. Wang replied, “We teach basic scientific background such as math, chemistry, and physics. Then we teach geological concepts like stratigraphy and mineralogy and structural geology. Then we take the students into specific fields such as oil and gas geology, petroleum engineering, mineralogy, mining geology and engineering, civil engineering, geological engineering, marine geology, geochemistry, geophysics, and whatever other fields branch out from those subjects.”

“Do your students have jobs when they finish their studies?” I asked.

“Oh, yes,” replied Mr. Wang. “Our students graduate, and many go to get advanced degrees in China, as well as in Australia, Europe, and the U.S. We also send many students into the oil and gas industry, the mining industry, engineering fields, and the like. We have graduates working at geological projects on every continent of the Earth, in the mining industry and in the oil extraction industry, building roads and dams across China, and as far away as Arabia, Africa, and South America, and even performing research in Antarctica.”

“So,” I asked Mr. Wang, “since you have 10,000 students, is your school the main school for the study of geology in China?”

“Oh, no,” he replied. “Ours is one of three geoscience universities in China. The other two universities are comparable to ours. And many other universities have their own college of geology. Beijing University, for example, is a very great school that is attended by many of the best students in China. It has a college of geology with about 4,000 students.”

“So,” I asked, “can you give me some idea of how many students are studying geology in China today?”

Mr. Wang thought for a moment. “If you add it all up,” he said, “there are about 40,000 or 50,000 students studying geology in China today at the university level. Maybe more, but I do not want to give you a number that is too high. Many of these students might not become geologists, because they will go into civil engineering or some related field. The Premier of China, Wei Jiabao, is a geologist, by the way, and worked as a geological surveyor in his youth. And many other students, such as those studying chemistry or physics in the university, might eventually become geochemists or geophysicists. But we are currently training about 50,000 or so geologists in China, across the nation.”

Are You Impressed Yet?

Are you impressed yet, dear readers? 50,000 students are studying geology in China today. That number is well over 25 times the number of college students who are studying geology in the U.S., which includes foreign students enrolled at U.S. institutions, and that is after something of a surge in enrollments in geoscience departments in the past two or three years. Back in 2004, according to statistics published by the U.S. National Science Foundation, there were fewer than 500 degrees granted in geology and petroleum engineering by all U.S. universities combined, and about half of those degrees were awarded to foreign nationals. The Chinese have 100 times that number in the pipeline.

It may help to make a military comparison. Consider that the U.S. is training geologists by the squad, or maybe by platoon, at the university level. The Chinese are cranking out geologists by the division.

Why Is This Important?

This is an important development. There is a revolution occurring in the scientific approach to understanding the Earth. The fields that make up geology, and related Earth and space sciences, are currently undergoing major advances that promote understanding of our planet as a number of interrelated systems. Many new realms of scientific investigation are emerging through the study of the connections and interactions between the atmosphere, hydrosphere, biosphere, cryosphere, solid Earth, and near space. Furthermore, geoscientists are playing critical roles in recognizing the extent and magnitude of human impact on the entire Earth system. And this understanding is gaining new context via the growth in knowledge of processes on other planets. So the more people who are out there and who understand at least the basics of geology (let alone the really hard stuff), the better for that nation.

Dave O’Reilly, chairman of Chevron, signs his name to many advertisements that state that the “easy” oil and gas has been found. If you are a frequent reader of Whiskey & Gunpowder, you know what we agree entirely with Mr. O’Reilly, and we carry the Peak Oil argument even further. Just as people say that the “easy” oil and gas has been found, so has almost all of the other “easy” mineral, energy, and water resources of the Earth been located and tapped. The future of modern civilization depends on how well any given group of people, from any given nation or organization, can understand how best to extract or harness the resources of the Earth that are not “easy” to access. So going forward, there had better be some geology majors coming out of the academic sweatshops, and the more the better.

100-to-1 Ratio

By way of comparison with the number of geology graduates, in recent years, U.S. law schools have awarded an average of about 40,000 law degrees annually to aspiring lawyers. So for each geologist that U.S. academia cranks out, the law school industry mills something between 50-100 lawyers. At the extreme end of the ratio, there are 100 new lawyers graduating from U.S. universities for every new geologist coming out into the work force.

Why is it that China is training armies of geologists while the U.S. is training armies of lawyers? And is there something ominous about that fact? Let’s examine a few aspects of this situation. What is going on?

What Is Going On?

The U.S. and China are about the same size in terms of land area so it is not that China needs more geologists to cover more ground. By the criteria of raw acreage, Russia and Canada should be graduating divisions of geologists. But Russia and Canada, the largest and second largest nations in the world by land area, are not doing this. The Chinese are leading the world in the training of large numbers of geoscientists.

In terms of population, China has 1.3 billion people and the U.S. has something over 300 million. So China has slightly over four times the population of the U.S. On a per capita basis, it might make sense for China to train more geologists. But still, there is a difference between China having four times the population and 50 times the geologists in training.

The U.S. is, of course, a developed nation with an advanced (some say “too advanced”), postindustrial (some say “too postindustrial”) economy. And “the world,” says Thomas Friedman, the famous columnist from The New York Times, “is flat.” Another way of framing the concept is to note that things that are on the uphill side will start to roll downhill in this “flat” world of ours. I am sure that you get the idea, dear readers.

The U.S., for example, has essentially built out its interstate highway system, much of which is now clogged with automobiles and trucks speeding (well, crawling at times and in places) hither and yon, while China is just building the beginnings of its own system of national highways, and filling up the roadways with its own domestic version of motorized carriages. If China were to burn as much gasoline on a per capita basis as does the U.S., China alone would require the entire world’s daily oil output and then some. But that is just extrapolating the present into the future, and things are going to change dramatically long before something like that could occur, if it were even possible.

And the U.S. has built up many great cities, while China is still building out its own collection of urban metropolises. Shanghai, for example, has seen the construction of over 300 new skyscrapers during the past 20 years. (One Chinese fellow once told me that it was too bad China did not use that steel to construct 300 offshore oil production platforms.) Overall, China is constructing buildings and roads and infrastructure that is the equivalent of a “new Houston,” about every month. And last year, in 2006, China added more electrical-generating capacity than exists in the entire state of California, where they have been building generating capacity for 100 years. So China is growing, and growing fast.

What Does China Need?

But still, what does this tell us about why China trains so many geologists and the U.S. trains so many lawyers? One might be forgiven for thinking that in a nominally communist state such as China, which is modernizing and evolving politically, the need would be for more lawyers to enforce basic human rights that have not been in place or effect for many decades. (Actually, China is training a relatively small cadre of lawyers too.) And one might think that in an advanced postindustrial state, such as the U.S., which has exhausted a significant fraction of its national energy and mineral resources over the past two centuries, the need would be for more geologists to locate and assist in securing new energy and mineral supplies. Yes, indeed. One might think that. But such is not the case.

One important way to differentiate the U.S. and China is to note the obvious point that the U.S. is a “rich” nation, certainly as measured in its own currency, the dollar. The U.S. can buy what it wants on the markets of the “flat” world, and use its uniquely situated dollar, the so-called “reserve currency” of the world economy, to pay for it. And China is, as its leaders like to remind the world, a “poor” nation that wants to get rich. “To get rich is glorious,” said former Premier Deng Xiaoping.

So can we say that rich nations need more lawyers? After all, much of what lawyers do is argue and fight over money. And where does this leave the poor people of the world? “The poor shall always be with you,” said Jesus in a famous comment. And yet another comment I have heard is that “What the poor people of this world need is not more lawyers.” This is according to an on old acquaintance of mine who is a federal judge. “They need more money,” he added.

So far, so good. And do poor nations need more geologists? After all, much of the work that geologists do is locate and define resources within the crust of the Earth, so that they can come back with other people and exploit those resources. Whether it is oil and gas, gold and silver, iron ore, sand or gravel, or falling water, this is what makes for an advancing, if not an advanced, civilization.

What was it that made for great civilizations in the past? In ancient Egypt, great civilizations arose out of the ability of a small group of people to understand and harness the powers of the Nile River. And in ancient Rome, it was the water-bearing aqueducts and the ores from the mines that permitted a great civilization and culture to flourish. In other words, these were civilizations that relied on people whom we would today call geologists and civil engineers. For a while, at any rate, it worked for the Egyptians and the Romans. Then the water aqueducts wore out and the minerals ran out and there was no replacing these things within a foreclosed time scale.

The Clash of Civilizations?

In his book A Study of History, Arnold Toynbee identified 21 major civilizations over recorded time. As Harvard professor Samuel Huntington pointed out in his famous essay, published in 1993, The Clash of Civilizations, “only six [of those 21 civilizations] exist in the contemporary world.”

“Civilization identity will be increasingly important in the future,” wrote Huntington, “and the world will be shaped in large measure by the interactions among…major civilizations.” Huntington went on to state that “The most important conflicts of the future will occur along the cultural fault lines separating these civilizations from one another.”

In much of the rest of his essay, Huntington went on to explain his thesis of “why civilizations will clash.” One of Huntington’s key points was that “Western civilization is both Western and modern. Non-Western civilizations have attempted to become modern without becoming Western...Non-Western civilizations will continue to attempt to acquire the wealth, technology, skills, machines, and weapons that are part of being modern. They will also attempt to reconcile this modernity with their traditional culture and values.”

You can agree with Huntington’s thesis, or you can disagree. But China’s massive educational effort to train geologists and related scientific personnel for the future indicates a national desire to, on the one hand, adopt the best scientific knowledge of the West. Yet China also intends, in its own unique way, to be among the civilizations that remain on any list of survivors compiled by any Arnold Toynbee of the future.

We live in a world in which the “easy” oil is gone, where Peak Oil looms, where the need for basic industrial resources and commodities is the key to the future existence of Western (and other) civilizations. And we live in a world in which the Chinese are training the scientific and technical cadre that will go out into the world and, one way or the other, find what their country needs and bring it home. There are armies, and then there are armies of geologists.

Until we meet again…
Byron W. King

For Whiskey and Gunpowder

Byron King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000 foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the current commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

The Los Angeles Oil Patch - Byron King

by Byron King

"LA is a great, big freeway," go the words to the song. It is also one of the world's great oil provinces, with historical oil extraction over the past 110 years of something near 9 billion barrels, and still counting. This volume easily places the oil production from the Los Angeles Basin in the ranks of Prudhoe Bay, Alaska (near 10 billion barrels), and about 50% greater than the East Texas field (about 6 billion barrels). So in this article, let's discuss Los Angeles and oil.

First, Los Angeles

First, let's discuss Los Angeles. I have been here before and I know what to expect, but the place never ceases to amaze me.

Just flying into the region, one encounters one of the busiest air traffic corridors in the world. The air controllers land giant airplanes two abreast on parallel runways at Los Angeles International Airport (LAX), with the rest of the airport work force moving about 78 million passengers per year through the jetways. This movement of humanity is the equivalent of about one out of every four people in the United States, although many of those 78 million are from foreign lands. And outside LAX, the freeways are even more crowded, at times and in places just wall to wall with cars and trucks, six lanes in each direction. Who are all these people? Where are they coming from? Where are they going? Driving their hummers to the store to buy some lipstick, maybe? Haven't they heard about Peak Oil? I guess not, but they will.

The Port of Long Beach, south of LAX, is similarly congested, with just plain miles of waterfront lined with pier facilities, steel forests of massive crane systems, and the adjacent and necessary railroad and heavy road infrastructure. This is all to the purpose of unloading the immense containerships that dock here. The biggest of the big vessels, larger than the old RMS Queen Mary that is now a tourist attraction at Long Beach, are carrying upward of 10,000 20- and 40-foot containers from foreign nations. Can you guess from which foreign nation most of these cargoes originate? Hint: Many of the ships belong to the China Ocean Shipping Co. (COSCO). Oh well, at least the Chinese lend us the money with which to buy their stuff. Or at least they have done so up to now. Something tells me that this also is related to Peak Oil.

And of those 10,000 containers on the large carriers, one port official told me that an average of 7,000 are loaded on rail cars for transport across the country, with about 3,000 containers loaded on motor trucks for the over-the-road, long haul that commences on I-710 and then eventually ends at a Wal-Mart or other fine store near you. And 3,000 trucks is one heck of a lot of trucks. Really, dear readers, the merge point where passenger traffic from Long Beach joins I-710 out of the port area is just a long line of fast-moving 18-wheelers, on occasion totaling something over 100 per hour, according to a uniformed representative of the California Highway Patrol.

And for any road-weary truck drivers who are paying attention, not far up from the Long Beach highway merge point one can see a billboard that the Burlington Northern Santa Fe Railroad (BNSF) has displayed, advertising for locomotive engineers. "It is like having a corner office with a view, except that it moves," states the house-sized help-wanted posting. Need a job? Want to drive a train? They are hiring down at the railroad.

And where else but in Los Angeles could you see none other than Evel Knievel, that daredevil of the road and master of the leaping motorcycle, give himself over to God and be baptized on Palm Sunday at the Crystal Cathedral by the Rev. Dr. Robert Schuller? Yes, dear readers, it is true. Evel Knievel is now among the saved. But does this mean that for all those years, as he was launching himself over dozens of parked school buses and speeding his way through flaming hoops, Evel was not quite right with God? Wow! Talk about a man who took chances and tempted fate. So now Evel is about 80 years old and suffering from a degenerative lung disease. He said that Jesus visited him in a dream and told him to get baptized. Thus, it was off to LA. It is never too late, I suppose, and you are never too old to do the Lord's bidding. And when you wish to do so, the City of Angels beckons.

The Early Oil Patch

So Los Angeles is a place of many people, a place of much industry, and a place of much of everything else, often to excess. And in that vein, I can say that LA is also a place of much oil.

Oil was certainly not unknown in Southern California long ago. The famous and geologically fascinating La Brea Tar Pits of Los Angeles have been bogging down, trapping, and preserving unwary animals since Pleistocene times. On one wall of the museum at La Brea, there is a display holding the skulls of 1,600 dire wolves, the remains of predators from long ago who thought that they spotted an easy meal trapped in the tar. But the predators quickly found themselves stuck in the goop and fast departing the gene pool as well. Nature had laid an oily trap for the complacent alphas at the top of the food chain, a message that probably has some contemporary meaning. But I need not belabor that point, certainly not to the Peak Oil scholars who read Whiskey & Gunpowder.

And within the archaeological past, the record is that for something over 10,000 years previous to our modern era, the ancestral Native Americans of SoCal collected oil from seeps. These proto-Californians did this in much the same way as did the Seneca tribes of what later became Pennsylvania. The Indians used the tarry oil to waterproof baskets and preserve rope and fishing lines, as well as as an early form of glue. And there was a variety of other uses, chronicled in numerous fine museums in and around LA.

The first "modern" oil well in the Golden State was drilled in Northern California in 1861, a mere two years after Col. Drake pounded down his hole at Titusville, Pa. Things slowed down during the Civil War, but by 1866, oil was being produced in commercial quantities in Humboldt County, north of San Francisco.

In the fall of 1892, a down-on-his-luck prospector named Edward Doheny drifted into Los Angeles from his previous failed adventures elsewhere. Doheny noticed that LA residents were gathering the "brea" (Spanish for "tar") from tar pits to use as fuel in place of scarce coal or lumber. Doheny applied his miner's knowledge and began to dig pits and follow the oil traces. Before long, LA of the 1890s was in the throes of an oil boom to rival that of Titusville in the 1860s, if not the Gold Rush of 1849. Speculators bought leases, tore down houses, erected derricks, and began to produce the oil from shallow rock formations. Parts of Los Angeles began to resemble a forest of derricks that rivaled any oil boomtown from back East. The coastline, along what would become the Pacific Coast Highway, was in many areas a line of oil derricks. California was on the oil prospector's map.

The Los Angeles Basin

Oil exploration in the early days of the 20th century pretty much consisted of prospectors following the shows and seeps and drilling the obvious structural features, particularly the folded rock sections called "anticlines." Fortunately for the early prospectors, the Los Angeles sedimentary basin is among the richest oil provinces on the planet, and is filled with shows, seeps, and anticlines.

These shows, seeps, and anticlines are the surface representations of more than two miles worth of layered Miocene and Pliocene sediments filled with a rich, organic, and petroliferous heritage. Adding to the mix, the relatively recent geologic, tectonic, and structural history of the region has provided an almost perfect thermal history to bring the organic matter into what is called the "oil window." That is, the source rocks have been buried within the depths of the Earth and heated to a point at which oil and gas formed. Then the oil and gas migrated into literally thousands of "traps" that are layered like pancakes from near the surface, down more than two miles to the crystalline basement rock that underlies LA. We cannot neglect to mention the extensive faulting of the region. This has been the source not only of the famous earthquakes, but also has contributed to bringing much of the oil and gas into existence, by aiding in its entrapment.

Aside from the hard work involved in finding and lifting out the oil and gas, there are hundreds of lifetimes worth of geologic and other scientific study just in the Los Angeles Basin alone. And there is a small army of geologists, engineers, and other researchers who do exactly that to earn their daily bread. So Los Angeles is not all just movie stars and fancy divorce lawyers. It is a scientific treasure house.

Back to the Oil Biz

With many people following in the oily footsteps of Doheny, by the 1920s and 1930s, there were numerous oil and gas discoveries in Los Angeles that were, by any standards, simply immense.

The Signal Hill oil field, for example, east of Long Beach, was discovered in 1921. The original reserve volumes are estimated at more than 1 billion barrels, and the number will never really be known, due to poor record keeping over many decades up until the 1950s. Early in its development, the locals called it "Pin Cushion Hill," due to the literally thousands of wells that went down to produce oil. The place had more wood on it than many mountains of the Sierra Nevada; the trees of the Sierra Nevada were cut down and used to erect derricks and pumping facilities. Today, the oil operations are still being carried out by a company called, appropriately enough, Signal Hill Petroleum Inc. Oil wells are located side by side with $1 million homes, and peoples' backyards have easements crossing them for gathering pipelines and water injection lines. Unlike in the past, however, the modern operations are pumping large volumes of water to obtain the relatively smaller volumes of oil. Still, this pays for itself, and overall produces quite a bit of petroleum.

The Wilmington Oil Field, for another example, discovered in 1936, is utterly gigantic. It stretches from Torrance in the northwest to offshore Long Beach and farther to the southeast. It is 16 miles long and 4 miles wide, with original reserves of over 1.4 billion barrels onshore and 1.2 billion barrels offshore, for a total of 2.6 billion barrels. Oil-producing beds have been located at depths between 2,000-10,000 feet, and there are probably additional oil-producing zones that have not been accessed. The field may extend to the southwest, under Pacific Palisades, but we cannot say for certain, because there has been little drilling in that pricey locale over the years. The homeowners in the area have kept the drillers out. Again, much of the original oil has been removed, but there is still a lot left to recover.

There are other oil fields in places that are well known to many people familiar with Los Angeles, but the locales are not exactly known for their oil production in the public perception. There are oil fields beneath such high-end locales as Huntington Beach, Newport Beach, El Segundo, Los Angeles downtown, Century City, Cheviot Hills, and even Beverly Hills. Beverly Hills High School has oil wells right next to the football field. One drill site with more than 60 wells, drilled directionally to as far as a mile from the surface entry and casing, is located in what looks like a 10-story office building, all of two blocks from the Beverly Hills city line. Director Steven Spielberg's mother lives down the street. And lore has it that the "Jed Clampett" of the TV show The Beverly Hillbillies fame was named after a local Los Angeles mineral rights owner of that same name ("J.D. Clampett") who is now immortalized by the whim of a scriptwriter.

All in all, there are 55 known oil fields in the Los Angeles area, with something over 30,000 producing wells and an equal number of older, plugged, and abandoned wells. (There may be far more than 30,000 wells, but the number is not known, due to poor record keeping in the good old days.) Something like 9 billion barrels of oil has been extracted from the rocks over the past century or so. Much of the contemporary oil production involves pumping "oil-stained water," but as I noted above, it adds up to quite a bit of extraction per day.

There are probably more oil fields that could be found beneath the streets of LA, because almost all of the past exploration in the urban part of the basin was performed before the mid-1960s. By the late 1960s, the public perception of the oil industry had turned negative, and even the likes of the well-connected Armand Hammer and his Los Angeles-based company Occidental Petroleum could not get drilling permits in most parts of the Los Angeles region. So the past 40 years have been a time of oil companies extracting product from existing wells, maintaining what wells they have, and very occasionally extending or redrilling an aging well. There is virtually no "modern" seismic work going on, and very little drilling. Even redrilling old wells takes a lengthy permitting process, and there is quite a bit of political opposition from people who don't think twice about turning the keys and starting the engines of their nice cars.

The potential for new oil discovery is there, though. There is really no way that the early oil exploration found "all" of it. The hydrocarbon traps are far too subtle and stacked, deeply buried, and truncated by extensive faulting and permeability pinch-outs. So the older forms of exploration found only the obvious deposits, not the more clandestine deposits. In the modern oil industry, advances in the field of sequence stratigraphy, structural modeling, and seismic methodology, coupled with directional drilling and what is called "extended reach drilling," have made it possible to find and extract such deposits. And it would be quite possible, from a technical standpoint, to drill the oil deposits even in a built-up urban area such as Los Angeles. But these oil deposits will probably never be drilled, due to modern city development, coupled with NIMBY attitudes and political opposition.

The Wealth Beneath the Streets

Los Angeles is an immensely wealthy area. There is money from the entertainment industry, manufacturing, transportation, banking, and many other lines of work, both legal and illegal. LA is an immense city, filled with people from every corner of the world. But most people have no idea of the vast oil wealth beneath the streets of metropolitan Los Angeles -- even most Angelinos, to include many Angelinos who live literally next door to an oil pump. Why is this? I suppose because all are busy living their own lives and worrying about their own issues.

But one way or another, we are all products of the Oil Age. No one can escape this fact. Oil makes modern society what it is. You drive it, you fly it, you wear it, and you eat it. In Los Angeles, you certainly breathe it. Even NIMBYs drive hummers, and in tony, high-rent Beverly Hills, people live on the oil patch, and I don't just mean the mythical Jed Clampett.

Until we meet again...
Byron W. King

for Whiskey and Gunpowder

Bio: Byron King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000 foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

Stalin Lives! - Byron King

by Byron King

YES, DEAR READERS, Stalin lives on Russian television. The Los Angeles Times recently published an article on the late-deceased absolute leader of the late-deceased Union of Soviet Socialist Republics (USSR), and on that I will comment shortly. But first, allow me to explain the byline.

I am in Long Beach, California this week, attending the annual convention of the American Association of Petroleum Geologists (AAPG). Why not? I have been a dues-paying member of AAPG for 30 years (even during my Navy days) and have learned quite a bit about the world of oil and gas by participating in the organization and reading its many excellent publications.

As for the annual convention, a lot of the premier oil finders in the world are here in Long Beach, as well as people from many of the critical vendors who sell articles and services to the oil industry. Everyone is gathered together to talk shop and compare notes about what is going on in the energy industry, from remote sensing to seismic, from exploration prospects to drilling decks, from total depth to the pipelines.

So this convention is exactly where I ought to be, considering that my beat is oil and other natural resources. And yes, it means that I must travel to sunny Southern California. It's a tough job and somebody has to do it. But I do it all for you, dear readers. As the week wears on, I will be writing about the AAPG convention, and you can be certain that the best of the information that I pick up here will find its way into future articles in Whiskey & Gunpowder, as well as into the other Agora Financial publication for which I write, Outstanding Investments.

The Man of Steel

I mentioned above that last week the LA Times published an article about a television series currently being broadcast on Russian television concerning Joseph Stalin. This prompts some thoughts about the late comrade and generalissimo, and what the revival, if not the rehabilitation, of Stalin's legacy may tell us about what is happening in Russia.

The man's real name was Iosif Vissarionovich Dzhugashvili, born 1878 in Georgia, and died 1953 in Moscow. Early in his adult life, Dzhugashvili studied for the Russian Orthodox seminary. But not long into his godly pursuits, he gave up notions of sacrificing material things on Earth for the prospect of gaining them in heaven. Instead, young Dzhugashvili pursued material things on Earth, adopting and embodying a hard line of Marxism and communism in the process. Through his own brand of that ideology, the man pursued these material things with a vengeance. "The death of one person is a tragedy," he once commented. "The death of a million is a statistic." You have to be a hard, cold person to think like that. And the Georgian adopted a name that suited his character. He called himself Stalin, which in Russian means "man of steel."

One would truly have to be a child who was, as the modern expression goes, "left behind" in school not to have heard about and to know at least something of Stalin. Stalin was one of the key players in the Bolshevik Revolution of Russia in 1917. He worked with Vladimir Lenin to found the USSR out of the remains of the Russian monarchical government. After Lenin's death in 1924, a death in which some scholars believe that Stalin played a role, Stalin rose rapidly to power in the USSR and ruled that nation with a grip of...well, with a grip of steel, until his own demise due to complications from a stroke. Yes, a stroke. At least that is what the Soviets said about how Stalin died, back in 1953. Not long afterward, they blamed a conspiracy of Jewish doctors.

Stamp out Religion in Russia

After seizing power in the 1920s, Stalin, the former seminarian, moved to stamp out religion in Russia, a place where Orthodox Christianity had traditionally been thought of as part of the very soil. Thousands of churches were destroyed, and the clergy sent away, which in Russia is very far away (to Siberia). As the 1920s and 1930s wore on, Stalin presided over the collectivization of property in Russia, to include establishing state ownership of essentially all resources both natural and man-made. Stalin collectivized Russian agriculture and drove off or killed any who opposed him, and many who did not. Similarly, Stalin forced a pattern of massive heavy industrialization on Russia, at something approaching a breakneck speed. And he broke many necks in the process. Stalin's secret police arrested and imprisoned anyone who was considered an enemy of the state, and of those there were many. Stalin was responsible for the deaths of well over 20 million of his fellow Soviet citizens, "a statistic" in his words, but a statistic that staggers the mind.

Brethren

In the late 1930s, Stalin purged his army of tens of thousands of its most senior and experienced officers. And then, in 1939 through his foreign minister Molotov, Stalin signed a nonaggression pact with Germany and its leader, Adolph Hitler. When Hitler's German armies attacked Russia in June 1941, they sliced through the ineptly led Russian formations and battered their way to the gates of Moscow. When, in July 1941, Stalin initially addressed his Soviet people to urge resistance to the Germans, the first word out of his mouth called his millions of listeners "brethren," a devout reference back to his seminarian days, and to the ancient Orthodox religion that he had done so much to destroy. When all else was failing, Stalin attempted to enlist God into the Red Army.

A Common Soviet Soldier

During the war with the Germans, Stalin's son Yakov was captured by the invading troops. At one point, the Germans sent a message offering to bargain with the Soviets over the return of Yakov. Stalin replied with words along the lines that the leader of the Soviet Union does not concern himself with the fate of a single "common Soviet soldier." Yakov eventually died in German captivity. The Man of Steel had settled the issue.

The fate of this "common Soviet soldier" concerns us in this article because a rather idealized and sentimental, even maudlin, version of Stalin's relationship with his son forms part of the background to a 40-part series currently running on Russian television, called "Stalin Live." The theme of the show is a rather flattering portrayal of an elderly Stalin, a few weeks before his death, recalling and flashing back to events from the past. The show is presented as a history of the Stalinist period in the USSR, as recalled by the "Best Friend of Soldiers" himself.

The Legend of Stalin

To admirers of Stalin, of whom there are many in Russia today, the show is an educational and informative vehicle by which to bring the legend of Stalin to a younger generation of Russians. To many critics, however, the show is a long campaign of historical distortion and outright propaganda that glosses over and whitewashes the inexpiable crimes of a horrific dictator.

Georgian actor David Giorgobiani, who plays Stalin in the series, states that "Many more years have to pass before we can make an unbiased judgment on that great man [sic]...One hundred years from now, no one will pay attention to the fact that so many people perished and the costs were so terribly high." In reference to the war against the Germans, Giorgobiani states that "Everyone will remember that such a great country was saved" by Stalin.

However, Danill Dondurey, editor of a film-themed Russian newspaper, states that "In the show, Stalin is portrayed as the savior of the people, the country, and all of civilization, the leader who destroyed fascism...Not for a split second do we see Stalin soaked in blood up to his elbows, as he really was." And because the TV series is focused on Stalin just before his death, there is no plot device through which to offer the perspectives of Stalin's contemporary critics. There were, of course, those who knew Stalin well, such as Nikita Khrushchev who as Soviet premier later gave the famous "anti-Stalin" speech that denounced much of Stalin's legacy and sowed the seeds of the illegitimacy of the founding myths of the USSR.

"The message is clear," states Dondurey. "Russia needs a wise leader...The main goal of this show is to preserve and nurture in the people the desire to obey a supreme leader, to take pride in having a supreme leader, to see no alternative to this model in the development of society."

Apparently, this message is getting through, if not touching nerves. The LA Times article quotes one satisfied Russian who has a fond recollection of the good old days. States one fan of the series, a viewer named Viktor Kurenkov, "Under Stalin, we had the best weapons, the best planes, the best tanks. He built the country that was first to send a man into space. As for the repressions attributed to him, their scale was always exaggerated."

Mr. Kurenkov's sentiments are not exactly a minority view in Russia. In fact, no less an authority and scholar of the USSR than Russian President Vladimir Putin has called the demise of the USSR "the greatest geopolitical disaster of the 20th century."

A Word From the Sponsor

Interestingly, the Russian network NTV, which broadcasts the Stalin series, is owned by the state-controlled entity Gazprom, the massive energy company that has effective monopoly control over the vast natural gas resources of Russia. According to editor and critic Dondurey, by sponsoring and broadcasting such a program that glorifies the Stalinist past, the Russian state is essentially promoting and encouraging the trend toward authoritarianism in contemporary Russian political life. So the broadcast of the "Stalin Live" show is not exactly the equivalent of, say, Texaco sponsoring the New York Metropolitan Opera over the past many decades.

The show's producer, Grigory Lyubormirov, states that his goal is to portray both the historical Stalin and the myth of Stalin. "Our Stalin is not only Joseph Dzhugashvili. It is Comrade Stalin, (whose) myth is still alive in the minds of Russian citizens." No doubt it is.

Lyubormirov goes on, "I categorically refuse to show Stalin as a paranoid, bloodthirsty wolf, because everything Stalin did had ironclad logic to it...Stalin was doing all that for logical reasons. Stalin was responsible for everything that happened in the Soviet Union after 1924, everything good and everything bad."

The Medium and the Message

So we see in Russia a popular television program, sponsored by energy giant Gazprom, which tends to glorify Stalin and the days of his dictatorial reign over the USSR. The show depicts Stalin in the context of using communism and political repression to build a strong nation, defend Russia against foreign invasion, and save the Soviet state, if not the world, from German fascism. The series glosses over the almost bottomless, decades-long brutality of the Stalinist period. The series also elevates Soviet Communist cultural myth over historical reality, and recalls how a supreme leader was able to offer some semblance of what the producer depicts as domestic stability and security from external threat to the Russian people.

All of this may well be emblematic of the current political evolution within Russia. There is no question that Stalin was a critical player on the history of the 20th century, and understanding Stalin is helpful to understanding how our world came to be in its present state. But the message of the Russian series "Stalin Live" is ominous, particularly because it fits with so much else of what we are currently seeing in Russia, particularly in the area of Russian resource nationalism.

That is, the Russians are going out of their way to rewrite and reform, if not simply to renege and abrogate, agreements from the 1990s. Their goal is to recover Russian state sovereignty and control over natural resources from any semblance of foreign control, particularly foreign control over energy resources. The recent well-publicized troubles that Exxon and Shell have had with their projects on the Russian island of Sakhalin, or BP and the Sakhalin gas project in northern Russia, fit neatly into this new political paradigm. To the extent that any foreign business interests are permitted to operate in Russia, especially energy interests, it is only so long as they play the game, suffer along with whatever indignities are hurled their way, and look the other way when the Russian state displays its iron fist.

As more than one nation has learned to its eventual sorrow, the Russians will go their own way in this world. And it is not as if we in the West could (let alone, should) ever muster, let alone apply, sufficient resources to change the fundamental trajectories of Russian history. But we should at least understand the risks inherent in where the world's largest country is headed. And wherever that trajectory is headed, it is not reassuring to learn that a show distorting history and glorifying Joseph Stalin is among the most popular items on Russian television.

Until we meet again...
Byron W. King

for Whiskey and Gunpowder

Byron King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000 foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

Energy and Private Equity, Part II - Byron King

by Byron King

What prompts me to write about PE is its current relation to investments in the energy arena. According to one authoritative estimate by Cambridge Energy Research Associates (CERA -- which has been so opposed to Peak Oil theory, but which also does quite good work in other areas), the U.S. electric power sector will require about $800 billion of new investment by 2020. By way of comparison, the current net book value of the U.S. power sector is about $700 billion. So right away, the discerning mind can figure out that it will require significant outside investment to keep the lights on in the U.S. over the next 15 years. Much of that new investment will probably come from PE.

Private Equity and Energy Investment

One large deal that is in the news is the proposed, $45 billion-plus takeover of the Texas utility TXU by a group composed of PE players KKR and Texas Pacific Group. The PE players want to take TXU private, and run the power houses and distribution channels themselves. The interesting angle of the takeover is an “environmental” play, as well as a financial offer for the stock. That is, the PE group is promising to cancel up to eight proposed pulverized-coal power plants that TXU has previously announced its intent to build. By changing TXU’s management and strategic direction, the proposed PE takeover will focus on using a mixture of conservation methods and new, more “green” generating capacity, to lower the impact of TXU power-generating activities on the environment in general and the atmosphere in particular. Will it work? I suppose that anything can work, if the management and funding are present. And anything can fail to work, where the will, ways, and means are lacking.

Energy Trends

The point to keep in mind is that PE is recognizing some ominous energy trends in the U.S., and beginning to do what smart money often does best, which is to take advantage of the situation. That is, some really big money is now stepping up to the plate. Here is a summary of what is going on.

For the past two decades, there has been strong demand growth in the U.S. for electricity and natural gas, both of which are considered relatively clean and convenient energy sources at the point of use. But due to chronic underinvestment in the U.S. energy infrastructure over the same past two decades and more, reserve margins for electricity and natural gas have been tightening. There is very little in the way of “spare” capacity at the lower-cost, “base-load” level, and in many instances, the spare capacity that does exist lacks the transmission facilities to move it from where it is to where it is needed. (This is true even with renewable energy supplies, such as wind power. Almost all wind farms are located in rural areas, far from the urban load. So there is a need for new transmission infrastructure to move the electricity from the point of generation to the area of use.) The bottom line is that on both the hottest and coldest days of the year, the U.S. power system is stretched to its limit as was, for example, demonstrated so dramatically by the cascading power outage that affected the Northeast U.S. and Ontario in August 2003.

Thus, there are looming requirements in every region of the U.S. for new-build decisions in the fields of basic energy supply and power production, plus generation, transmission, and distribution, as well as overall requirements to upgrade systems for safety and reliability. But capital costs for construction are soaring due to worldwide inflation in the prices of many basic elements such as cement and steel, machinery and pipe, copper wire and welding rods, and, of course, the basic engineering and project management talent that brings it all together.

This situation dovetails with a large number of immensely complicated issues of environmental regulation, rate-base calculations (necessary for determining appropriate ROI), and design and technology assessments. And through it all, the past few years have also been ones of severe commodity and price volatility, both due to improper market manipulation (such as what Enron did with electricity in California early in the decade), and geological factors such as Peak Oil and Peak Gas in North America. Add to this the growing scientific and political concerns about the emission of greenhouse gases, which is leading to calls to burn less carbon. Things are just plain complex. No, make that really complex.

The View of Private Equity

I do not propose to speak on behalf of all private equity, nor to praise PE more than it deserves. But in general, the situation that we are describing lends itself to some of the self-described advantages, if not virtues, of PE.

The convoluted situation in supply, new-build decisions, construction, and overall regulation is causing many existing players in the energy business to re-evaluate their stakes and revise their business strategies. Recently enacted regulatory and accounting rules are forcing many publicly held companies to bear costly burdens that they would just as soon avoid (Sarbanes-Oxley reporting requirements come to mind.) On the best of days, many firms face a shortage of capital, yet they are held accountable by the public and the regulatory agencies for any failings or lack of results. So there are incentives simply to, as the saying goes, “monetize assets,” and certainly to get rid of unnecessary or underperforming assets.

The “For Sale” signs for energy infrastructure are beginning to come out, publicly and, on numerous occasions, not so publicly. And PE is standing there, with checkbooks in hand -- after the obligatory due diligence, of course.

PE can afford to, and in many respects must, focus on cash return, as opposed to mere book income, and lacks the prurient fixation on quarterly results that drive many bad decisions by publicly held companies in other instances. Most of the funds that go into PE are locked up for terms ranging from five years to as long as a decade or more. So PE managers can be patient and deliberate in making their investment plans over time frames that approach a decade. PE can also accelerate development decisions, because it is spending its investors’ money, and not what is referred to as the “ratepayers’” money, and, when appropriate, PE can make efficient use of hedging.

Again, I am not making a blanket endorsement of any one investment method or another. But I believe it is worth discussing that PE advertises a focus on long-term value creation that is often absent in the quarterly driven world of publicly traded companies. My view is that whether a company is PE or publicly traded, much of any firm’s success depends upon the kind of people who are making the decisions. Your success or failure always depends on how the assets are managed and how the people perform.

One Great and Historic Success

One great historical example of a person who took a nest egg and, through a then-prevalent form of PE, turned it into the foundations of a fortune was Andrew Carnegie and his investment in the Columbia Oil Co. in the early 1860s. I wrote about this in another article in Whiskey & Gunpowder, entitled “Columbia, the Gem of the Oil Patch.” Carnegie took his earnings from his job with the Pennsylvania Railroad and, in an early form of PE, bought into an oil company near Titusville, Pa. The Civil War era gains and dividends from the Columbia Oil Co. provided Carnegie with the money he used to change careers and get himself into the steel business. The rest is history. You can look it up.

Until we meet again,
Byron W. King

for Whiskey and Gunpowder

Bio: Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Energy and Private Equity, Part I - Byron King

by Byron King

I RECENTLY HAD occasion to deal with some people who are involved in the "private equity" (PE) side of the energy business. I am bound by a confidentiality agreement not to say too much about the details of their project. But I was surprised at how much money these people controlled, the quality of the management team, and the scope of their ambitions in the energy arena. I know that many of our readers are financially sophisticated and probably know quite a bit about the topic I am discussing. But I also thought that some Whiskey & Gunpowder readers might be interested in learning more about PE and other investment instruments. So that is the subject for today.

What Is Private Equity?

What is PE? In a broad and general sense, PE is a term that commonly refers to any type of "equity" investment in an asset, but in which the underlying equity does not trade freely on a public stock market like the New York Stock Exchange or Nasdaq. Also, in a general sense, PE refers to the manner in which the funds have been raised, namely on the private markets. Many people use the term "private equity" interchangeably with the term "private equity funds," which are committed pools of managed capital, raised from private sources.

Currently, some PE funds invest across a broad spectrum of industries. KKR, Texas Pacific Group, Blackstone, and Carlyle are well-known names in this area, and there are many others. Some PE funds focus on investments in particular industries, such as energy, technology, or health care. In many instances, PE firms invest in companies listed on public exchanges, by buying up the stocks and taking them private. But PE might also purchase a company from private holders, such as an individual or family (often as part of a succession plan), or from a closely held group of owners who want to cash out.

Spectrum of Investment Methods: Not a Hedge Fund

PE funds are part of a spectrum of investment methods. For comparison, let's look at how PE differs from hedge funds. Hedge funds are vehicles that work with an investment of pooled funds, almost always open only to "accredited investors." (See the end of the article for a short discussion of accredited investors.)

PE tends to take a relatively long-term view of investing, such as a four-eight-year horizon (and sometimes even longer), for reasons that we will review toward the end. In contrast, a hedge fund usually is focused on short-term trading opportunities, with traders using instruments such as arbitrage, swaps, derivatives, and other forms of financial leverage. In many instances, and again unlike the case with PE, the hedge fund traders might have little fundamental knowledge of the companies or industries in which they are conducting their trading, but to them it does not matter. The hedge fund traders are following the trading action, the price movement, and the overall market volatility in an effort to capture short-term gains.

Hedge funds usually charge a performance fee against both the principal within the fund, and any gains over time. Despite much criticism of their short-term view of just trading in and trading out of stocks and other ownership instruments, hedge funds have grown very much in size and influence on both the public securities and private investment markets. (Last summer, I discussed hedge fund investments in the mining business, in an article entitled "Money, Mines, and Nickel," published Aug. 1, 2006.)

Private Equity, Ventures, and Places Where Angels Tread

PE also differs from venture capital (VC). PE focuses on more mature companies or business efforts. VC, in contrast, invests in the early stage of startup enterprises. Thus, there is relatively more risk associated with the VC investment. Typical VC is provided by professional or institutionally backed outside investors, infusing cash in exchange for shares (and often one or more seats on the board) of the company that is being assisted. VC finds its place in the market because the enterprise under consideration is usually too risky for standard capital markets or sizeable bank loans. But while VC is usually high risk, it can offer the potential for above-average returns.

VC funding is a step up from what is called the "angel investor." An angel is an individual or pool of funds that provides capital for a business startup, except it does so at an earlier stage than does the VC. That is, someone starts a business in the proverbial garage, or otherwise on a shoestring and a prayer. Not a few businesses have been started using the line of credit on a founder's personal credit card. Angels and their capital are said to fill the gap in startup financing, between what are known as the "three Fs" (friends, family, and fools) of seed money, and the more discriminating VC.

As most people who have ever tried can attest, it is usually difficult to raise more than a few hundred thousand dollars from friends and family. (You might get lucky with the fools, but even that will eventually come to an end.) At some point, the fact is that red ink is thicker than blood, and your friends and family, and even the fools, will shut you off. The standard in the industry is that most VC funds do not consider investments under about $1-2 million. Thus, angel investment is the common second round of financing, in the range of about a quarter million to couple of million dollars, for startup companies with great hope, if not high growth prospects. Typical for startups, angel investments carry high risk and need to offer very high returns on investment (ROI).

The fact is that a large proportion of angel investments are completely lost when early-stage companies fail. Thus, professional angel investors look for investments that have the potential to return at least 10 or more times their original investment within about five years. Angels tend to be an expensive source of funds, but cheaper sources of capital such as bank loans are usually not available for most early-stage ventures. And after the initial five-year development period, the angel is looking for an exit strategy such as an infusion of cash from VC, or an initial public offering of stock (IPO) or other acquisition. That "other acquisition" may also be a sale to PE.

Private Equity Takes Over

So whether it is a former startup that grows and eventually sells out to PE or a mainstream, old-line firm that gets bought out from a major stock exchange, PE moves in to take over. Private equity funds typically control management of the companies in which they invest. Often, PE brings in new management teams that focus on making the company more valuable. At least that is the idea.

Critics, of course, have a less charitable view, which can be boiled down to the accusation that PE takeovers are little more than "strip and flip" operations. That is, the new guys take over and promptly lay off lots of personnel (usually, goes the claim, they lay off the ones who know how to run the business). Then the new guys sell the good stuff, load the company up with debt, and bail out by selling the corporate carcass to gullible investors who are too dumb to know any better. There have been quite a few examples of this kind of relatively destructive PE management activity in the past few years (one fast-food chain that shall remain unnamed offers a Whopper of an example), but then again, one can cite publicly traded companies that have financially engineered themselves into the dirt as well (Sunbeam and the mercurial "Chain Saw" Al Dunlap come to mind). As is the case with many things in this world, however, the truth depends upon the situation. Nothing is all good or all bad.

In the second part of this two-part article, I will discuss further the role of private equity in the development of energy resources in the U.S.

Until we meet again,
Byron W. King

for Whiskey and Gunpowder

P.S.: There are substantial risks involved in placing funds with relatively unregulated, complex, and leveraged investments such as private equity. Hence, these types of investment instruments (along with the likes of venture capital or hedge funds) are normally open only to professional, institutional, or otherwise accredited investors. The restrictions are often implemented through limits on participating investors or minimum investment amounts.

The criteria established by the U.S. Securities and Exchange Commission (SEC) are as follows:

Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer

Any natural person [i.e., not a corporation] whose individual net worth, or joint net worth with that person's spouse, excluding principle residence, at the time of his purchase exceeds $2,500,000

Any natural person who had individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year

Any trust with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase of the securities is directed by a person who has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment

Any organization that was not formed for the purpose of acquiring the securities being sold, with total assets in excess of $5,000,000

Any entity in which all of the equity owners are accredited investors.

Bio: Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

A Function of Price and Technology - Byron King

by Byron King

On March 5, 2007, The New York Times published an article entitled “Oil Innovations Pump New Life Into Old Wells,” by Times correspondent Jad Mouawad. The title of the article referred to recent increases in oil extraction from older oil fields, noting:

“Within the last decade, technology advances have made it possible to unlock more oil from old fields, and, at the same time, higher oil prices have made it economical for companies to go after reserves that are harder to reach. With plenty of oil still left in familiar locations, forecasts that the world’s reserves are drying out have given way to predictions that more oil can be found than ever before.”

As is the case with much of what gets published in The New York Times, some of the information in the article is true. But then again, to the well-trained and highly polished Peak Oil mind, the article has a lot of disinformation in it about what is the long-term state of the oil patch. In a not-so-subtle manner, the Times article appears to diminish the credibility of the Peak Oil argument. Specifically, the Times article focuses on allaying any Manhattanite fears of future scarcity of conventional oil by suggesting that “new technology” will locate and extract immense volumes of oil with which mankind will, to all intents and purposes, power its way into a brighter future. It is as if we can now all kick back, pop a beer, wipe the sweat from our collective brow, and say, “Whew, we dodged that Peak Oil bullet.”

Oh yeah? Not so fast, pilgrims. Let’s take another look at this “new technology” subject matter. And allow me to amplify some of the substance of what the Times is attempting to relate.

Porosity, Permeability, Rocks, and Reserves

The “world’s reserves are drying out,” states the article. I would not put it quite that way. Oil reserve estimates are a complex mixture of science and art, but the aggregate number depends in large measure on price. Reserve estimates do not really “dry out.” Estimates or volumes or quantities may rise or fall, but there is nothing dry about them, except for the Securities and Exchange Commission rules that govern how publicly traded oil companies have to do the underlying engineering-based accounting. And is it true that, as the article states, “more oil can be found than ever before”? No, not exactly. The oil in older oil fields has, of course, by definition, already been found. The oil may or may not have been extracted and recovered, but it has been found. Getting it out is the problem, and for that we have to drill holes into the rocks. Always have, and always will.

Oil, and associated natural gas and water, accumulates in what are known as “reservoir” rocks over periods of geologic time, meaning very long time periods often as not measured in millions of years. Reservoir rocks are almost always sedimentary rocks that have a fortuitous combination of what is called “porosity” and “permeability.” (In rare locales, such as offshore Vietnam, metamorphic, and even igneous, rocks serve as reservoir rocks. The oil originated elsewhere, and has migrated into porous, permeable metamorphic or igneous rocks. We will address the migration process shortly.) The porosity of a rock is a measurement of the volume of the (usually) microscopic “pore” spaces between the mineral grains that make up the bulk of the rock. And the permeability of a rock is a measurement of the ability of a fluid to flow through these small pore spaces. (Just to be clear, oil is not located in big, empty voids deep within the earth. There are no natural “pools” of oil, like gigantic underground swimming pools, waiting for someone to drill and pump the oil out.)

But a reservoir rock also needs some sort of “cap,” or trapping mechanism, to hold the oil inside its pore spaces. Over geologic time, even very minor leaks (along, say, fractures or faults) can allow essentially all of the fluids, and certainly the valuable ones like petroleum, to drain out of a rock formation. Rock formations such as salt beds or tight, very impermeable shales often serve as cap rocks, keeping the petroleum fluids sealed within the reservoir rock. And all of this assumes that somewhere nearby is a “source” rock, from which the oil and natural gas originated. Usually, the source rocks are located in close proximity to the reservoir, but not always. In some of the conventional oil fields of Western Canada, for example, the source rocks are as much as 100 miles from the reservoir rocks, indicating quite a long migration to their ultimate resting place.

So the oil that lubricates and powers the world originated during various geological periods of the past and came to be formed in source rocks. Eventually, and subject to a multitude of geologic forces and phenomena acting over relatively long periods of time, the oil migrated from the source rocks into permeable reservoir rocks. As the oil flowed through these reservoir rocks, it came to occupy the pore spaces within the grains that make up the underground oil reservoir. Some sort of cap, or other lithologic seal, kept the oil in the reservoir rocks, awaiting discovery in the years since Col. Drake ushered in the modern Age of Petroleum, starting in 1859 at Titusville, Pa. This oil in the ground is usually called the “original oil in place” (OOIP).

Gushers and Blowouts

While we are on the subject of oil in the reservoir (or OOIP), I should mention that in order for the oil to be able to migrate into a drill hole, there is a requirement for “reservoir energy.” That is, some form of energy has to be present within the reservoir rock to cause the OOIP to move from the pore spaces where it has resided for these many years into a hole in the ground. Reservoir energy can be present due to the fact that most oil contains dissolved natural gas, usually under pressure, and in some locales under great pressure. (I write from personal experience on this one.) So the oil, with the “higher pressure” gas dissolved within, tends to flow, via that above-noted permeability, through the pores of a rock formation and into the “lower pressure” hole that the drillers have put down into the ground. The aboveground analogy would be the carbon dioxide (CO2) gas dissolved in a bottle of soda pop. When you remove the cap from the bottle, the dissolved gas starts to fizz towards the low-pressure open end of the bottle.

In the olden days, when people who drilled for oil did not quite understand the process, they would drill down into a rock formation and the reservoir energy would overwhelm the hole in the ground. This ofttime led to a rapid explosion of pressurized oil from the ground, famously known as a “gusher.” The old movies and photos show people acting happy, and even dancing with joy when a well “gushed.” But unbeknownst to the early oil pioneers, this was a disastrous waste of the reservoir energy of the oil field, because it caused the dissolved gas rapidly to exit from the reservoir rock and leave much of the otherwise recoverable oil behind. Thus, much of modern petroleum engineering has to do with monitoring and maintaining reservoir pressures as high as possible for as long as possible during drilling and producing operations, so as to recover as much of the OOIP as is possible. And yes, things like gushers can still happen in today’s highly engineered world, but we call them “blowouts.” They are not happy occasions.

Neglected Resources: 2 out of 3 Barrels

The New York Times article further discussed the process of oil recovery, stating:

“Typically, oil companies can only produce one barrel for every three they find. Two usually are left behind, either because they are too hard to pump out or because it would be too expensive to do so. Going after these neglected resources, energy experts say, represents a tremendous opportunity.

“‘Ironically, most of the oil we will discover is from oil we’ve already found,’ said Lawrence Goldstein, an energy analyst at the Energy Policy Research Foundation, an industry-funded group. ‘What has been missing is the technology and the threshold price that will lead to a revolution in lifting that oil.’”

This description makes it seem like oil companies have always had more control over what happens than is actually the case. “Too hard to pump out,” states The New York Times article. Well, sort of. What the article is attempting to describe is the process whereby, over time, about one-third of the conventional oil in a given reservoir migrates from its geological location to the drill hole. The reason that it migrates is because of that above-noted reservoir energy. Think of the high pressure oil (or at least, the “higher” pressure oil) moving towards the low-pressure drill hole. This migrating oil is that one barrel out of three, on average. (Some oil fields yield higher percentages of the original oil in place. Other oil fields yield far lower percentages.) By the time that the one barrel makes its way to the borehole, the reservoir energy has diminished to the point that it is not sufficient to mobilize the other two barrels. So that oil remains behind, in the reservoir rock formation.

For most of the history of the oil industry, oilmen have been at the mercy of the reservoir energy in the rock formations deep beneath their feet. If you were fortunate enough to locate low viscosity oil with a high measure of reservoir energy, then you could extract a high percentage of the OOIP. Col. Drake’s first well at Titusville, for example, produced a “Pennsylvania” grade of crude oil that was exceedingly slippery (i.e., low viscosity, such that it feels smooth like hand lotion) from a thin, porous sandstone with excellent permeability, and the reservoir energy that benefited Col. Drake was what is called “water drive.” That is, ground water was essentially pushing the oil from the rock formation into Drake’s 69-foot-deep hole in the ground. Under these circumstances, recovery of OOIP from the sandstones beneath the Titusville region was relatively high over the years.

Enhancing the Reservoir Energy

At the other end of the oil patch spectrum, however, the Kern River oil field, discovered in 1899 near Bakersfield, Calif., yields a highly viscous sort of oil, loosely described as “heavy oil.” There was never all that much reservoir energy to begin with, so the original rates of recovery of OOIP were in the range of perhaps 10%. In other words, nine out of 10 barrels of OOIP were left in the rock formation.

But in recent years, as The New York Times notes in its article, Chevron has been using steam-flood technology and computerized 3-D reservoir modeling to boost the output of the Kern River field’s heavy oil reserves. For something over two decades, Chevron engineers have injected high-pressured steam into the oil reservoirs, to enhance the reservoir energy and to mobilize the oil. This has allowed Chevron to pump out more oil. Production from the Kern River field had slumped to about 10,000 barrels a day in the 1960s, but with the steam flood, it now has a daily output of about 85,000 barrels. And even after a century of production, Chevron engineers say there are many more years of productive life left in the field, and much more oil to be pumped from Kern River, although all the steam in the world will not prevent the inevitable phase of irreversible decline in production over time.

According to The New York Times article:

“At the Kern River field…millions of gallons of steam are injected into the field to melt [sic] the oil, which has the unusually dense consistency of very thick molasses. The steamed liquid is then drained through underground reservoirs and pumped out by about 8,500 production wells scattered around the field, which covers 20 square miles.

“Initially, engineers expected to recover only 10% of the field’s oil. Now, thanks to decades of trial and error, Chevron believes it will be able to recover up to 80% of the oil from the field, more than twice the industry’s average recovery rate, which is typically around 35%. Each well produces about 10 barrels a day at a cost of $16 each. That compares with production costs of only $1 or $2 a barrel in the Persian Gulf, home to the world’s lowest-cost producers.”

While there is nothing objectionable about what The New York Times article states, the article misses an important point with those “millions of gallons of steam.” There are immense amounts of energy involved in generating the steam that goes into the ground, and this is one of the reasons why Kern River oil is up to 16 times more costly to produce than Persian Gulf oil.

And not to quibble, but pumping steam is not exactly new or revolutionary technology. Oil well drillers near Titusville were documented as pumping steam down well bores as early as 1862, at first in an effort to remove the paraffin wax that built up inside the well casings. Then, over time, people noticed that a “steam bath” tended to give a kick to subsequent production. These old drillers may not have understood the engineering aspects in any detail, but they knew what worked out in the field.

Then as now, making steam required boiling water, which required more capital investment, equipment, energy, and labor, so it drove up costs. Plus, making and pumping steam added to the danger of working in the oil patch, and it was dangerous enough to work just around oil wells with no hot steam pipes crisscrossing the landscape. So the steam-pumping process added even more potential for leaks, sparks, and explosions. Thus, for many years steam pumping was used only in exceptional circumstances. As long as oil was cheap and relatively available from other oil fields in other locales, there was no particular incentive to add more layers of complexity to a process that was difficult enough on good days.

But above a certain price for a barrel of oil, the extra cost of steam, or other methods of enhanced oil recovery, can pay for itself. The New York Times article noted that the Kern River is…

“Littered with a forest of wells, with gleaming pipes running along dusty roads. Seismic technology and satellites are now used to monitor operations, while sensors inside the wells record slight changes in temperature or pressure. Each year, [Chevron] drills some 850 new wells there…

“There are very few workers in the field. Engineers in air-conditioned control rooms can get an accurate picture of the field’s underground reservoir and pinpoint with accuracy the areas they want to explore. None of that technology was available just a decade ago.”

What a Difference a Decade Makes

No, a decade ago, oil was selling for as little as $10 per barrel. And the Kern River field was a high cost outpost of marginal wells that produced viscous oil that was (and still is) hard to handle and refine. But things have changed, and now the place is booming.

Worldwide, reserves of conventional oil, also known as the “easy” oil, are declining and not being replaced. Oil companies, from the likes of large majors like Chevron to the national oil companies (NOCs) of many nations, are looking further afield for oil supplies, and are also looking at older areas to attempt to recover what they left behind the first time around. In some areas, old oil fields that were long ago abandoned and plugged with concrete are being drilled again.

“There are finite resources in the ground, but you never get to that point,” states Jeff Hatlen, an Chevron engineer, in a discussion with the reporter from The New York Times. “Peak Oil is a moving target,” Mr. Hatlen said. “Oil is always a function of price and technology.”

Price, Technology, Time, and Depletion

Yes, oil is a function of price and technology. But oil is also a function of time and depletion. So over the long term, and as existing reserves deplete, we have to ask the question, “What price and what technology?” That is, how much are people willing to pay, and for what kinds of equipment, to recover oil from the ground? Of course, every good business student learns early to ask, “What is the return on investment?” But the next question, that far fewer people even understand how to ask, is “What is the energy return on energy investment (EROEI)?” How much can anyone pay, and what measure of resources is it worth to get to that last marginal barrel? And the ultimate question is, “Can price and technology move the marketplace for energy faster than oil reserves are declining in the face of depletion?”

We are, of course, all going to find out, should we live so long.

Until we meet again…
Byron W. King

For Whiskey and Gunpowder

Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

The Shell Answer Man, Part II

THE PRESIDENT OF Shell Oil Co., John D. Hofmeister, is about midway through a 50-city speaking-and-listening tour, talking about the national energy situation on behalf of Shell. Last week, he brought the tour to Pittsburgh. In Part I of this report, I provided an overview of the energy message that Mr. Hofmeister is delivering on behalf of Shell, embodied in the title of the speech that he has given, in one form or another, in many cities, “How the U.S. Can Ensure Energy Supply for the Future.”

Shell’s Mr. Hofmeister is talking about oil and natural gas, of course, which is what you would expect from the man who runs Shell. But he is also talking about other energy resources such as coal, tar sands, oil shale, heavy oils, biomass, fuel cells, solar power, wind power, and even plain-old energy conservation. It is quite a comprehensive overview, and the theme of the presentation reflects the energy investments and technological pathways that Shell is pursuing. When asked why he is not discussing nuclear power, Mr. Hofmeister states that Shell does not have corporate expertise in that field and thus he is willing to leave that radioactive energy source for others to review. Fair enough.

It Sounds Like the Peak Oil Issue

What is that old expression about, “If it walks like a duck and looks like a duck and quacks like a duck”? Here we have the president of one of the world’s largest publicly traded oil companies, in business for well over a century, traveling back and forth across the land to hold a national energy discussion. The man from Shell states in no uncertain terms that conventional crude oil is getting harder to find and extract. He begins his talks by offering a definition of “energy security” from the perspective of Shell Oil. That is, energy security means ensuring an available, affordable supply of energy for the present, the foreseeable future, and generations to come. The implication is that Shell is on the cutting edge of a strategic vision for delivering energy supply to the nation’s and world’s consumers within a market system, and working to be part of any transition or transformation from where we are now to where we will be many decades from now.

In his speeches across the U.S., Mr. Hofmeister has clearly described how the search for oil and natural gas reserves is moving into distant, dangerous expensive places to operate. Of course, he promotes opening up remote and expensive places for drilling, such as the U.S. Outer Continental Shelf (OCS). This OCS issue is, if you do not know, part of the DNA of every true oilman, certainly including this correspondent. And Mr. Hofmeister is discussing the massive, long-term, and very costly investments that his company is making in alternative energy sources, from tar sands of Canada to oil shale in Colorado. He describes other exotic and expensive energy investments that Shell is making in coal gasification and coal-to-liquid (CTL) technology, as well as in fuel cells, solar cells, and wind power. It all sounds, to the informed listener, like Mr. Hofmeister is discussing the Peak Oil issue.

The Peak Oil Paradigm

All of what Mr. Hofmeister is saying certainly fits in to the standard Peak Oil paradigm, which is that mankind has generally located, if not discovered, most of the conventional crude oil that there is to find in the crust of the Earth, and has produced and consumed something near half of it. That is, out of a conventional, worldwide resource base of conventional oil that is estimated by some knowledgeable commentators at about 2.2 trillion barrels, about 90% has been discovered and about 1 trillion barrels have been extracted and consumed over the past 150 years or so. At the present time the global oil industry is pumping the world’s known oil reserves at a rate of about 1,000 barrels per second, or 85 million barrels per day (mbd), or about 31 billion barrels per year. And the global economy is, as frequent readers of this column know, consuming or otherwise burning up almost every drop of that oil. And not to get too preachy, but watch what happens if just a couple of hundred thousand barrels per day of production (near a rounding error from a production base of 85 mbd) go off line, such as occurred last August when BP closed the Alaska pipeline.

So do the math, dear readers. Follow the facts. Watch the trends. Mankind is at the top (or “peak”) of the conventional oil production curve. The world’s major oil provinces and largest oil fields are barely holding steady in production (Saudi’s Ghawar Field, for example), or are in irreversible decline (U.S. Lower 48 and Alaska, North Sea, Mexico’s Cantarell, Kuwait’s Burgan, China’s Daqing, Russia’s Samotlor and Romashkino, and many others). The world is pumping and burning oil that was discovered decades ago. And despite massive and costly efforts at exploration, overall, the global oil industry is pumping conventional oil reserves out of the ground at a far faster rate than it is discovering new reserves. So in the past few years, “new” oil production has barely kept up with depletion and decline in volumes produced from older areas.

“Call It a Banana”

Yes, do the math. These facts are the heart and soul of the Peak Oil discussion, dear readers. There is a lot of conventional oil in the crust of the Earth, and obviously, there is enough to support current daily global oil production of around 85 mbd, at least for a while. But only for a while. (How long? Good question.) What happens when conventional oil volumes begin to decline in an appreciable manner? This is exactly why big oil companies like Shell, and most government-owned oil companies, and many other large and small firms from around the world, are investing feverishly to develop alternative sources of hydrocarbon production, other energy sources, and advanced energy conservation concepts.

Thus, the future of conventional oil production bodes ill. The most likely forecast is that the rate of oil extraction will hold more or less steady and bounce along, at a maximum production plateau of about 85 mbd for some relatively short-term period of years, and then eventually follow a downward trending and irreversible curve of decline. Call it “Hubbert’s Peak” if you wish, after the title of the fine book by Princeton geology professor Kenneth Deffeyes. But Hubbert’s Peak is only a label. Call it something else, if you wish. You might even want to quote the late, great Groucho Marx and “Call it a “banana.”

Plenty of Uncertainty

So yes, the Peak Oil scenario rests on the assumption that the world’s largest oil provinces, in both area and volume, have been located from Texas and Mexico to Saudi Arabia and Iran, from the North Sea to West Africa, from Western Siberia to Northern China, from many spots here to many other spots there. But no, for all the purists out there, this does not mean that we know where every deposit of conventional oil is located, to a precise grid description on the face of the planet. There is plenty of uncertainty about the future of exploration and production. There are, to be sure, many dry holes yet to be drilled.

Rest assured that the world’s oil industry will be exploring for oil and drilling wells far into the future, to recover the valuable hydrocarbon product from the rock beds of the Earth. And it means that the future of conventional oil exploration will be one in which those geologists and drillers look for smaller and smaller oil fields, in more and more remote locales. There will, of course, in that oil-searching future be plenty of good jobs and good wages for geologists, geophysicists, and engineers of every ilk and stripe, and drillers and logisticians and the myriad of oil service personnel who make it all happen. And again, to his credit, Shell’s Answer Man Mr. Hofmeister has given more than a few speeches addressing the industry-wide chronic shortage of personnel with critical skills that is currently hamstringing many exploration and production efforts.

The Peak Oil Question

As I mentioned in Part I of this article, Mr. Hofmeister takes questions as well as gives speeches. And so I asked him straight up about Peak Oil: “Mr. Hofmeister, does Shell Oil have a corporate policy or position on the concept of Peak Oil, which you know was pioneered by former Shell geologist M. King Hubbert?”

And here is exactly what Mr. Hofmeister said: “Among informed Shell executives, there is a rejection of the Peak Oil theory.” Peak Oil is, he stated, “based on flawed assumptions.”

Mr. Hofmeister listed three reasons why Shell executives reject Peak Oil theory:

Peak Oil deals with conventional oil and does not take into account sources of unconventional oil, such as tar sand, oil shale, and heavy oil.
Peak Oil assumes that technology is static, when, in reality, there have been “huge strides” in the ability to enhance oil recovery from older oil fields.
By diversifying energy resources, “People will switch demand to other energy sources” long before conventional oil runs out.

Amplifying this last point, Mr. Hofmeister mentioned an old saying that has been, I believe, first attributed to former Saudi Oil Minister Sheikh Zaki Yamani, that “The Stone Age did not end for lack of stones, and the Oil Age will not end for lack of oil.”

And finally, Mr. Hofmeister made another comment along these lines: “We will reach Peak Oil, but not for lack of oil.”

Not for Lack of Oil?

Earlier in this article, I mentioned the old expression that “If it walks like a duck and looks like a duck and quacks like a duck…” Well, there are more ducks here than on Old McDonald’s Farm. I honestly admire and commend Shell Oil Co. and Shell’s Mr. Hofmeister for going around to discuss the energy predicament of the U.S. and the world. Mr. Hofmeister is saying many of the right things, in my view, and he is in a position to know what he is talking about. But what is going on? What is with the Peak Oil denial by Shell?

According to the president of Shell, Peak Oil is “based on flawed assumptions”? I just do not get that. Actually, the mathematical support of the Peak Oil argument is based largely upon industry-supplied data sets. That is, Peak Oil is based on historical and current production data for conventional oil, and the only place to get that kind of data is from industrial summaries such as the BP Statistical Review or Oil & Gas Journal or by summarizing collections of government-mandated data. So not to overstate the issue, but it is the camp that diminishes or denies Peak Oil that is using the flawed assumptions.

Conventional Oil

The critics focus on the point that the Peak Oil concept focuses on conventional oil, and does not take into account other hydrocarbon alternatives. Well, yes, after a fashion. Peak Oil is, and always has been, about “conventional oil” recovery. The discovery and recovery of conventional oil has been occurring for about 150 years, since 1859, when Col. Edwin Drake pounded down his famous well at Titusville. When former Shell geologist M. King Hubbert first articulated the Peak Oil concept in the 1950s, conventional oil was the whole ballgame. And the world is now at the point at which conventional oil extraction is a more or less flat, at a production rate of something over 80 million barrels per day (mbd), with the balance in natural gas liquids and other energy fluids.

And this “conventional” oil distinction of the Peak Oil argument is not some sort of “flaw” in the assumption; it is critical to understanding the point. With the exception of just a few million barrels per day of heavy oil, very sour crude, oil from tar, and a few other exotic forms of hydrocarbon, the entire world’s industrial liquid fuel infrastructure is wired and plumbed for conventional crude oil. This is the 150-year legacy of past investment at work. For example, the plastic and rubber gaskets in the engines of almost all of the world’s 500 million or so motorized vehicles are designed for use with oil-based gasoline, and rapidly corrode if ethanol is used for fuel.

Look at it from the other perspective. The world simply does not have the industrial infrastructure to produce 85 mbd of “alternative” forms of hydrocarbon fuel and there is no program in place to construct it, certainly not over the next few decades. After 20-plus more years of investment in the tar sands of Alberta, for example, the government of Canada is forecasting at most about 3 mbd of synthetic crude oil production by 2025. And this will require immense amounts of fresh water and natural gas, the supplies of which are entirely problematic.

And for all intents and purposes, there is simply no oil shale industry (let alone a world-scale oil shale industry), despite over a century of periodic hype to include the research performed by Shell in Colorado. Coal-to-liquid (CTL) efforts are embryonic, and it is a fair statement to say that no one really knows what a large-scale CTL industry will look like, what the technology will entail, what the environmental impact will be, and what the energy return on energy investment (EROEI) will be.

Technology

The critics also often argue that the Peak Oil thesis does not take into account new forms of technology that expands the reach for oil to deeper and more remote locales, or new equipment and processes that improve oil recovery from rock formations.

Actually, the improvement in technology is one of the things that demonstrate the point of Peak Oil. The “easy” oil has been found, and Shell states as much in its corporate advertising, along with Chevron, BP, and most other oil companies that pay good money to advertise their efforts. A deepwater oil well in the Gulf of Mexico, for example, costs in the neighborhood of $125 million, as was the case with Chevron’s 28,000-foot Jack-2 well that drew so much attention in September 2006. Would Chevron, or any other oil company, drill 28,000-foot wells that cost $125 million if there were cheaper alternatives? Deep, remote, expensive exploration and production wells make the case for Peak Oil, not diminish it.

As for enhanced oil recovery (EOR) methods, again these technological advancements make the case for Peak Oil. On the one hand, EOR is a market response to the rising price of conventional oil, so EOR merely illustrates that oil is becoming scarce and worth more investment to recover from the ground.

At the same time, EOR merely allows the oil producer to recover a higher percentage of the oil in place. EOR does not “make” any new oil in the rock formations. What is down there is down there, and EOR is just a way of leveraging your investment in a hole in the ground to get more oil out, and often as not to get it out more quickly. Whether your methodology is to drill horizontal wells or to perform multilateral completions or to inject water or gas to keep up the reservoir pressures or pump surfactants or other chemicals into the oil-bearing formation, what you are doing is mobilizing the oil and accelerating oil extraction from the future into the present.

The Peak Oil problem with EOR comes when the distant future shows up and becomes the present. Then, your extraction drops precipitously and your irreversible decline curve kicks in with a vengeance. Oil-producing regions such as Mexico’s Cantarell, the North Sea, or even parts of Saudi Ghawar illustrate the point. These great oil-producing regions have been the subject of EOR since the 1980s, and now their annual production decline rates are in the range of 12% and more. And compounding the problem, the decline in production leaves a major gap in the supply curve going forward, particularly since no one is “discovering” any other new oil provinces like Ghawar, Cantarell, or the North Sea.

So EOR is a technological means of pulling more oil out of the same holes, but it is not a contradiction to the argument embodied by the term “Peak Oil.”

Consumer Behavior

As for the argument that people will change demand and consumption habits long before we “run out of oil,” this is actually part and parcel of the basic Peak Oil thesis as well. Peak Oil is real, as are markets and market behaviors. Prices rise, and people react.

And of course, people will change their habits as conventional oil becomes more and more scarce, and expensive, going forward. They will have to, just as the world changed its consumption habits in 1978 and 1979 when the Iranian Revolution took almost the entire petroleum output of that nation offline within a matter of months. When the oil was not there, it was not there. Prices rose. People changed behavior. Economies crashed. And so it will be in the future. We can prepare or not, with a sense of urgency or not.

Moving the Goal Posts

So to my way of seeing things, it is the critics of the Peak Oil concept who keep attempting to redefine the terms. In one intellectual form or another, they keep trying to move the goal posts whenever some new evidence comes along that makes a new point within the discussion.

But this two-part article concerns Shell Oil Co., its president, John Hofmeister, and his traveling speaking tour. Shell and its president are attempting to hold a national energy discussion and to get people at the grass roots thinking about whence will come the nation’s energy supply in the future and the need for a true long-term national energy strategy. The Shell Answer Man is putting quite a bit of valid, accurate information about energy out on the table for all to see, from the depleting oil situation to the need for significant energy conservation efforts. Bravo.

We can disagree about this feature or that of what Mr. Hofmeister is saying, and even differ about the name on the label. Is it “Peak Oil” or no? I happen to believe that it clarifies the thinking process to call things by their correct name. But then again, it all may be of little consequence in the long term. We shall see. As our Arab friends say, “The dogs bark. The caravan moves on.”

Until we meet again…
Byron W. King

for Whiskey and Gunpowder

Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

The Shell Answer Man, Part I

DO YOU REMEMBER the “Shell Answer Man,” dear readers? He was part of a television advertising campaign by Shell Oil Co. back in the 1970s, in reaction to the oil shocks and gasoline shortages of that era. The Shell Answer Man was a nice-looking, pleasant-sounding fellow who would appear on the TV screen to ask and answer basic questions about driving in general and gasoline in particular.

With simple language, and in a disarming and folksy manner, the man from Shell would explain things that related to fuel usage, like how proper tire inflation was good for your gas mileage. Or he would discuss how “jackrabbit starts” wasted gasoline. Over a period of time, there were a variety of topical ads along those lines. If you were somewhat savvy about driving an automobile, there was nothing particularly new or revealing in the message. But if you were what we might characterize, with all due respect, as the “average consumer,” blissfully dwelling in energy La-La Land, then the Shell Answer Man offered some good advice. Well, it was good advice if you followed it.

John D. Hofmeister

And so today we meet John D. Hofmeister. He is a nice-looking, pleasant-sounding fellow who happens to be the president of Shell Oil Co. And he is in the midst of a 50-city lecture tour, on behalf of Shell, giving speeches with a title along the lines of “How the U.S. Can Ensure Energy Supply for the Future?” On Feb. 8, 2007, he brought the show to Pittsburgh.

First of all, Thank you, Shell Oil Co., and thank you, Mr. Hofmeister. No matter what else I say in the following two-part commentary (and frequent readers know that I will have a few things to say), I certainly appreciate that a large company like Shell would make the effort to hold what amounts to a “national energy discussion.” And it says something important that a big, publicly traded company like Shell would send no less than its president out on the road to give the pitch. I suspect that such a senior corporate officer might have a few other things to do, like run Shell Oil. But then again, educating the public about the nation’s energy supply and answering peoples’ questions on the subject might just be more important over the long term than squinting at a few more spreadsheets full of obscure data or buttering up the stock analysts.

A Well-Traveled Road

And what a road Mr. Hofmeister has traveled in the past year or s from Miami to Minneapolis, New Orleans to Irvine, Seattle to Washington, the National Press Club to Harvard Business School. The guy gets around. He calls it a “speaking tour,” of course, because he is giving speeches. But he also calls it a “listening tour,” because he takes questions and offers answers, however well rehearsed. (It’s OK, really. Shell has to be careful not to run afoul of the Securities and Exchange Commission or its many volumes of regulations. So everything has to get scrubbed by the lawyers.)

The typical gig involves a visit to some burgh where Mr. Hofmeister has a lunchtime speech scheduled before a local assembly of worthies, such as the World Affairs Council of this hamlet or that village or town. Also on the schedule, time permitting, is a morning visit to an area high school or college to meet with the young people and hold give-and-take sessions with those inquiring minds. And often as not, the indefatigable Mr. Hofmeister holds a “town meeting” later in the day, at which forum just about anybody can (and ofttimes does) show up to make caustic attacks on the oil industry, if not to bellyache about the price of gas.

In Pittsburgh, for example, one precocious high school student asked one of the most painful of all questions that any oil company executive can hear: “How much do you get paid, Mr. Hofmeister?” Ooooooh! That’s what I compare to a hot welding spark dropping down your shirt. But Mr. Hofmeister gave the nosey kid a good answer: “I get paid more than a rookie player for the Pittsburgh Steelers, but less than [Steelers quarterback] Ben Roethlisberger.” Not bad, Mr. Shell Answer Man, not bad at all.

Just by way of payroll perspective, a rookie player for the Pittsburgh Steelers makes more money than a federal judge, albeit without the lifetime tenure. And although the Steelers’ player No. 7 did steer the team to a Super Bowl championship back in 2006, Ben Roethlisberger has a disturbing habit of riding a motorcycle without wearing a helmet. How smart is that? Yet the Steelers quarterback gets paid more than the guy who runs Shell Oil Co.? Go figure.

And the man from Shell might have added that he gets paid to manage a company that produces real energy and industrial products that people buy and use, and that he makes a heck of a lot less than most of the senior guys at places like Goldman Sachs or the myriad rich guys who run those Greenwich- or London-based hedge funds. Really, dear readers, how much gasoline or engine lubricant have you ever bought from Goldman Sachs, let alone from those Greenwich and London hedge funds? But I digress.

The Edge of Secure Supply

The public speaking coaches will tell you that it is often good to begin your speech with a story to gain the attention of the audience, and Mr. Hofmeister began his lunchtime talk with one heck of a tale. In the aftermath of hurricanes Katrina and Rita in 2005, almost all of the U.S. Gulf Coast refineries were down due to flooding and other storm damage. Shell had 300,000 barrels of refined product in storage at its Baytown, Texas, refinery, which was essentially the only supply available to the entire Southeast region, but there was no electricity with which to run the pumps. Whoops!

Shell employees and contractors were working feverishly to rig up electric generators at the Texas facility, but it was a race against time, over a 48-hour period, until the Plantation and Colonial pipelines -- the major trunk carriers for refined product between Texas and the Southeastern U.S. -- went dry. If word escaped of the predicament, Shell executives believed that many members of the consuming public would have panicked. Then “panic-buying” would have immediately kicked in and rapidly drained whatever fuel was left in the supply system. The entire U.S. Southeast, home to about 60 million souls, could have been caught in a situation in which there would be no fuel available anywhere. It fell to Shell’s Mr. Hofmeister to call the U.S. Secretary of Energy and deliver the bad news.

But like the cavalry arriving near the end of a John Ford Western, Shell’s hardworking people hooked up the Texas facility with electric power, with all of about 12 hours to spare. Shell started pumping gas into the pipeline system. There were, you may recall, spot shortages of fuel in the U.S. Southeast, but no regional lack of product. Still, as Mr. Hofmeister put it, it was a close call and the U.S. was and remains “on the edge of secure supply.”

Shell’s View of the World

In his comments in Pittsburgh, and in his talks to other groups across the U.S., Mr. Hofmeister has noted that he is “president of a company that creates a product that consumers don’t want to see, touch, taste or smell, even though they buy it by the gallon day after day.” At the same time, he notes, the mission of Shell is to “renew the American industrial energy base in order to grow energy supplies in this country -- which are ample.” Mr. Hofmeister continues: “We are deeply, deeply invested in the hydrocarbon economy and there is no short-term exit from the hydrocarbon economy, unless we want to suspend economic growth and development.”

Mr. Hofmeister, in the course of his tour, has on numerous occasions amplified these comments. His talks identify to listeners a key dilemma of our time, that “we are the beneficiaries of an industrial age, having given way to a post-industrial age, having given way to an information age, in which the world is ever more seeing the role of information and the manipulation of information as part of the business model upon which we will build wealth creation.” But the Shell man has noted, “Sustained growth of the post-industrial information era can only occur predicated upon continued development, and in some cases redevelopment, of the industrial infrastructure which many people think we have moved beyond.”

Redeveloping Industrial Infrastructure

In the course of his talk in Pittsburgh, as in his other speeches in many other cities, Mr. Hofmeister addressed the litany of present and future potential energy resources. He spoke at length, as you might expect, about oil and natural gas.

Considering that the focus of the man from Shell was on explaining the need and urgency of developing and redeveloping energy and energy-related industrial infrastructure, it was odd, certainly to this correspondent, that he did not address the concept of depletion. Most people tend not ever to have heard of depletion, let alone to understand it. In fact, I have met many people who think that oil wells just gush away, forever and ever, world without end, amen. They say things like, “If only those damn oil companies would uncap those wells they have shut in down in Texas, we’d have plenty of oil.” Oh please, dear readers, can you feel my pain? But then you explain to these misguided souls how depletion works. Then, unless they are total idiots or utter ideologues (and believe me, dear readers, there are some total idiots and utter ideologues out there), they understand why it is necessary to go out and drill new wells to replace the ones that have declined. So memo from King to Hofmeister: Discuss depletion, even if there are idiots and ideologues who just won’t get it.

Mr. Hofmeister’s emphasis was on the political fact that about 85% of the U.S. Outer Continental Shelf (OCS) is off-limits to oil and gas exploration, as are large areas of federal- and state-owned lands in the U.S. These areas have significant potential to become productive areas for oil and gas, but the environmental opposition is such that the political will is lacking to lease any blocks and spud any wells. And even if, let’s say tomorrow morning, the political will magically appeared for OCS development, it would take much time and investment for any productive potential to come to fruition. Considering that it takes between 10-15 years to begin to develop an offshore province, the decision to open or not to open up the U.S. OCS will impact the energy destiny of the country in 2020 and afterward. In my view, people in the future will look back and think rather unkind thoughts about us for our current inaction, but that is another subject for another time.

To his credit, Mr. Hofmeister acknowledged that drilling the OCS will not “solve” the U.S. energy dilemma. As an oilman, of course, he painted a favorable scenario for future hydrocarbon production from the OCS. But the guy clearly is smart enough to understand (and honest enough to say) that drilling up the OCS is not the answer to the nation’s energy problems going forward. The take-away point was the geologically correct observation that future oil and gas production from the OCS has to be a part of any overall U.S. energy strategy. It will be, of course. It is just a question of time, and how desperate the U.S. becomes for oil and gas as in the future as imports inevitably decline from other parts of the world. It’s that depletion thing.

Mr. Hofmeister spoke about Shell’s efforts in developing other forms of hydrocarbon fuels, as well. These include the “Alberta oil sands” (even though we all know that the correct description is “tar sands”). He discussed the future of liquefied natural gas (LNG) and the importance for the U.S. of having the facilities in place to import LNG from overseas. He discussed the use of domestic coal, noting that “The word ‘coal’ is usually associated with the word ‘dirty.’” The point was not lost on an audience in Pittsburgh, most of whom above a certain age could tell you a few things about dirty old coal. But Shell is focusing quite a bit of investment on a coal-related concept called integrated gasification coal conversion (IGCC), which allows for much cleaner combustion or conversion of the black rock, with the opportunity to capture and sequester the carbon dioxide byproduct. Shell has 15 IGCC projects ongoing in China. And among the other coal-related processes that the company president mentioned were coal-to-liquid (CTL), with which Shell is also well along in China. I have written at length about these energy resources, including Shell’s methanol projects in China.

Other areas of interest and investment by Shell include Colorado oil shale, in which Shell has pursued a 20-year research project. But any major investment in oil shale is, according to Mr. Hofmeister, “still many years away” for Shell. Mr. Hofmeister did not say it in so many words, but the tone of his voice seemed to emphasize the quantity of “many.” So don’t hold your breath. Oil shale has been the “fuel of the future” for a long time, and still is. And Shell is also investing in technology to upgrade heavy oil, of which there are voluminous amounts in the crust of the Earth. Again, this will be a technological stretch that plays out over many years.

According to Mr. Hofmeister, Shell is a major player in what he calls “second-generation biofuels,” meaning ethanol-derived “from nonfood-based cellulose material.” This includes plant stalks, wood chips, and even municipal waste. Why no enthusiasm for corn-based ethanol? Mr. Hofmeister has, on other occasions, explained it thus:

“I got 48 letters from attorneys general (in 2006) accusing us of price gouging
during the course of the last 12 months. It’s not fun to get accused by
attorneys general in 48 states of price gouging when in fact we’re working very
hard on bringing supplies. So the biofuel, we believe, stretches the gas supply,
but the cellulosic avoids the cost of food going up. What I really don’t want to
see is 48 letters from attorneys general accusing us of raising the price of
food in addition to the price of gasoline because of the extensive use of corn
and sugar.”

Shell is also investing in producing energy from solar films and fuel cells, and the company even produces in excess of 300 megawatts per day of electricity from windmill farms in seven states. So Shell has quite an energy aperture.

Energy Conservation

But simply focusing on future energy supplies is not enough, states Mr. Hofmeister on behalf of Shell. Shell believes in promoting a “culture of conservation”:

“We need a culture of conservation. Conservation does not come from turning the thermostat up a bit in the summer and down a bit in the winter. Conservation comes from the minds and the hearts of our engineers and our designers who can rationalize energy efficiency and who can design vehicles, homes, buildings, and appliances in ways in which energy efficiency is increased on an ever-constant-improvement basis. A culture of conservation drives energy efficiency forward for generations to come. We believe that a culture of conservation has to start with education, as does this whole backdrop of energy efficiency and energy education. Shell supports the notion of working with public policy leaders on a rational framework across the whole spectrum of energy development, but, in addition to that, supports the development of a school-based curriculum to educate our young people for generations to come about how important energy is to our life, to our economy, and to our standard of living,”

So in summary, according to its president, Shell Oil Co. is looking at and investing in production of traditional hydrocarbon sources of energy as well as developing novel means of producing energy supplies from alternate forms of carbon. And Shell is working on innovative energy alternatives, and supports conservation efforts. The company’s top executive is out on the road putting a human face on its corporate vision and interests, and giving good speeches about important topics.

In Part II, We Question the Shell Answer Man

So far, so good. And in Part II of this article, we will take things a few steps further and pose some questions to the Shell Answer Man.

Until we meet again….
Byron W. King

for Whiskey and Gunpowder

Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Worst Single Debris Event Ever

THE HEADLINE says a lot, so let’s start with that: “China ASAT Test Called Worst Single Debris Event Ever.” This is the lead into an article in the Feb. 12, 2007, issue of the authoritative McGraw-Hill publication Aviation Week & Space Technology. The term “ASAT” refers to the Chinese test of an anti-satellite system.

Wind and Cloud and Orbiting Debris

As you may know, China conducted an ASAT test on Jan. 11 of this year, destroying a weather satellite launched in 1999, designated Feng Yun 1C (FY-1C; Feng Yun translates as “wind and cloud”), then orbiting the Earth at an altitude of 537 miles. The January experiment (or the attack, depending on your perspective) was carried out with a kinetic kill vehicle launched by China’s Second Artillery Regiment using a small Chinese ballistic missile. News of the Chinese ASAT test was first revealed to the public by Aviation Week on Jan. 17.

A U.S. Defense official who reviewed the intelligence about China’s ASAT test said that the launch was detected by the United States in the early evening of Jan. 11, which would have been early morning on Jan. 12 in China. American satellites tracked the launch and trajectory of the medium-range Chinese ballistic missile toward the known orbit of the weather satellite, a sun-synchronous circular orbit inclined 98.6 degrees. U.S. space radars later recorded an expanding debris field. In particular, U.S. Air Force radar reports noted what were called “signs of orbital distress” in the days after Jan. 11. By Jan. 18, the radar data showed debris where the FY-1C spacecraft had been orbiting before.

Dr. Jonathan McDowell, an astronomer at Harvard who is a specialist in tracking space debris, said the FY-1C satellite was a cube measuring 4.6 feet on each side (1.5 meters), and that its solar panels extended about 28 feet (9 meters). He added that although the target satellite was launched in 1999, according to Chinese sources it was due for retirement. Still, the satellite appeared to be “electronically alive,” making it an ideal target. “If it stops working,” said McDowell, “you know you have a successful hit.”

Someone Should Tell the Foreign Ministry

If it stops working, you have a hit? Perhaps someone from the Second Artillery Regiment should tell the Chinese Foreign Ministry. Initially, Liu Jianchao, a spokesman for China’s Foreign Ministry, declined to confirm or deny that China had conducted an ASAT test, let alone destroyed one of its satellites. “So far,” he said on Jan. 20, “I have not been informed about it by relevant authorities. China has always stood for the peaceful uses of outer space and against introducing weapons into outer space.” Yes, of course.

Retired Col. Gen. Leonid Ivashov, the former head of the Russian Defense Ministry's International Military Cooperation Department, was more forthcoming. He stated to Moscow News that the Chinese weapon was “modeled on the Soviet IS-1 missile designed to destroy satellites that was developed in the 1970s.” So we have the Russians to thank for this? Pass the vodka.

In the U.S., some commentators (the usual suspects, of course) downplayed the significance of the test, saying China apparently used “simple technology.” A so-called “national security analyst” named Laura Grego, of the Union of Concerned Scientists in Cambridge, Mass., said, “It’s pretty low-tech. It’s essentially like throwing a rock at someone.”

Throwing a Rock? Not Quite

Throwing a rock, huh? Well, it depends whom you ask. “I think that the Chinese ASAT test is very troubling,” stated U.S. Defense Secretary Robert Gates at a Senate Armed Services Committee hearing. “And perhaps what is as troubling as the technical achievement is how one interprets it as a part of...[the Chinese] strategic outlook, and how they would anticipate using that kind of a capability in the event of a conflict, and the consequences for us of that.” So according to one of the key U.S. Defense officials, who happens to be a former director of Central Intelligence, the Chinese ASAT test is a “technical achievement” with “strategic” impact. Maybe it is not “like throwing a rock” at someone. Maybe it is less like a rock and more like rocket science.

All Quiet -- Lately, That Is

Development of ASAT technology began in the 1950s, in both the U.S. and former Soviet Union, not long after ballistic missiles began to fly. The first technical approach to the ASAT issue was to use air-launched missiles, because the basic technology was better understood. The U.S. began tests of an ASAT system in 1959, but initial results were poor and the first test launch missed its target by over three miles. “Throwing a rock” at someone can be hard work. After further failures, the U.S. ASAT project was halted in 1963.

We do not know a lot about the earliest Soviet efforts, due to the secrecy of that former regime. But not to be outdone by the U.S., the Soviets began to pour significant resources into an ASAT program in 1967 and actually built, tested, and deployed ASAT weapons starting in 1976. The Soviet ASAT system eschewed closing with a kill vehicle to a direct hit against the target, and instead was based on moving an explosive device into the vicinity of the target, and then blasting pellets towards the target satellite in a shotgun-like manner. This kind of ASAT device created a significant debris cloud in orbital space. Several Soviet ASAT tests were performed at relatively low orbits, and these tests created several significant debris clouds.

In response to the Soviet effort of the late 1960s and 1970s, the U.S. revived its own ASAT program in 1977. U.S. Defense contractor Vought developed an ASAT to attack satellites in low Earth orbit (LEO), a three-stage missile carrying a miniature homing vehicle designed to make a direct hit against the target. The Vought missile was designed to be fired from an F-15 Eagle in a steep climb. After one successful test to demonstrate the Vought technology on Sept. 13, 1985, in which an aging U.S. satellite was the target, the U.S. ceased further development efforts and never procured or deployed the system. It took about 17 years for the debris from that one U.S. ASAT test to fall from orbit.

In the 1990s, the U.S. invested funds in research and development of a more advanced ASAT device, incorporating more updated sensor and guidance technology, but never tested it. The U.S. currently has no operational or deployed ASAT devices, although the Air Force retains several prototypes of earlier designs in storage.

U.S. Assessments and Concerns

U.S. intelligence services have been following Chinese space developments in recent years. The U.S. Office of the Secretary of Defense went so far as to issue a report on July 19, 2005, that addressed China’s growing space capability. The report -- The Military Power of the People’s Republic of China 2005 -- claimed that China was developing and intends to field ASAT systems. The report stated:

“China is working on, and plans to field, ASAT systems. Beijing has and will continue to enhance its satellite tracking and identification network -- the first step in establishing a credible ASAT capability. China can currently destroy or disable satellites only by launching a ballistic missile or space-launch vehicle armed with a nuclear weapon. However, there are many risks associated with this method, and consequences from use of nuclear weapons.”

The 2005 U.S. report did not predict that the Chinese were developing, or could field, a working version of a kinetic kill device. But in a section of the report concerning what it labeled as China’s “Space and Counterspace” activities, the official U.S. document noted that Beijing has been building infrastructure for space-based command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) and targeting capabilities. The report stated:

“Building a modern ISR [intelligence, surveillance, and reconnaissance] architecture is likely one of the primary drivers behind Beijing’s space endeavors and a critical component of its overall C4ISR modernization efforts.”

One critic named Jeffrey Lewis, a research fellow at the Center for International and Security Studies at the University of Maryland’s School of Public Policy, was skeptical of the Pentagon’s assertions. At the time, Lewis told the Web site SPACE.com that “Although the 2005 edition does flatly state -- as have previous reports -- that China intends to field ASAT systems, the 2005 edition omits most of the evidence cited in previous reports, including discredited claims about the development of a parasite microsatellite and a ground-based direct ascent ASAT that was supposed to be fielded as early as this year.” Lewis added that, although the U.S. Department of Defense was asserting that China intends to deploy ASATs, “It’s pretty clear they don’t have any evidence to back that up.” Until now, of course. The Chinese have cleared up any confusion, and actually conducted a successful ASAT test complete with hard kill. So much for “discredited claims.”

Chinese Research and Development

While the U.S. assessment may not have included detailed or classified intelligence information, there is a large amount of Chinese research in the field of space control made public every year. Among the titles of significant Chinese publications are the Journal of Astronautics, Aerospace Control, and Modern Defense Technology. All of these learned journals have published original Chinese research in the past two years on kinetic kill vehicles -- for example, an article entitled “Modeling and Simulation of Guidance and Control of Kinetic Kill Vehicle in Terminal Process of Interception” by Gao Da-Yuan et al. in Journal of Astronautics (Yuhang Xuebao) Vol. 26, No. 4 (2005), Pgs. 420-424. Perhaps someone should send a copy to the University of Maryland School of Public Policy.

And according to unclassified U.S. Air Force information, the Chinese apparently conducted three previous intercept missions against the FY-1C satellite, on Oct. 26, 2005, and on April 20 and Nov. 30, 2006. These shots “missed” the target, but that does not mean that they were not experimental or technical successes. It may have been that the Chinese were testing other elements of their ASAT system, such as the launch vehicle, the guidance system, the closing and targeting subsystems, and the general command and control process. Finally, on the fourth shot on Jan. 11, 2007, the Chinese hit the satellite at which they were aiming.

Implications

The U.S. military is especially dependent on satellites for navigation, communications and missile guidance. The U.S. economy, and most other modern economies that rely on space-based communication pathways, could also be broadly damaged by disruptions of communications, weather, and other satellites.

China’s test of an ASAT weapon against its own satellite has increased the quantity of debris able to be tracked by more than 900 objects, or an immediate 10% increase in a figure that has otherwise accumulated in orbit over the past 50 years. This debris is a threat to essentially every spacecraft that orbits below about 1,243 miles.

China’s FY-1C satellite, orbiting at an altitude of 534 miles, shattered, along with the ASAT device, into thousands of pieces large and small, some of which were dispersed into a wide range of orbits ranging in altitude from 2,361 miles on the high end down to about 124 miles at the lowest, according to Nicholas Johnson, NASA's chief scientist for orbital debris and a longtime expert in the field. “This is by far the worst satellite fragmentation in the history of the space age, in the past 50 years,” he stated.

As of mid-February, the U.S. Space Surveillance Network (SSN) in Colorado Springs had cataloged 647 of the more than 900 items its sensors were tracking. On average, these kinds of objects must be at least 3.9 inches in diameter to be tracked from the ground, although smaller objects can be pinpointed using two radars located at the Haystack Observatory in Tyngsboro, Mass., operated by MIT’s Lincoln Laboratory.

NASA’s Mr. Johnson says that the debris models predict an eventual cloud of some 35,000 objects larger than 1 centimeter remaining in orbit. “Many of these debris will be in orbit for 100 years or more because the altitude of the breakup was so high,” he said. “Some will come down earlier, but the majority will be up there for a very long time.”

Space Control and Power Projection

Chinese spokespersons are fond of denying that China has, or can develop, imperial ambitions. The foundation of this argument is that China was an oppressed nation for almost two centuries, and its recent increase in economic and military power is simply a defensive reaction. China, goes the argument, is simply advancing from its past position of weakness, no matter what it does. Yet China, in its effort to demonstrate a capability that the U.S. and former USSR have not tested in over two decades, has fouled the nest of orbital space in a way that could just plain screw it up for everyone.

Michael Krepon, president emeritus of the Henry L. Stimson Center, a Washington, D.C.-based nonprofit organization involved with security issues, called the Chinese ASAT test a response to U.S. space policies. “The Chinese are telling the Pentagon that they don’t own space,” he said. “We can play this game, too,” is the Chinese message, “and we can play it dirtier than you.” Well, that is sure something of which to be proud.

Still, and contrary to the dismissive, if not cavalier, attitudes expressed in some quarters, China’s successful test of an ASAT weapon means that the Middle Kingdom has mastered critical space sensor, tracking, launch, guidance, and other technologies important for advanced military space operations. The implications range from the tactical and operational to the strategic and geostrategic. Based on its demonstrated technical ability, China is now in a position to use “space control” as a foreign and military policy weapon. This will greatly assist China in projecting its growing power, both regionally and globally.

Until we meet again…
Byron W. King

for Whiskey and Gunpowder

Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Peak Oil Shock

by Byron King

IN A RECENT story in the Fort Worth Star-Telegram, Shell Oil Co. President John Hofmeister was quoted about what he has learned while on his current national 50-city speaking tour. In 2006, Mr. Hofmeister and other Shell executives toured 25 U.S. cities, with visits to another 25 burghs and hamlets on the calendar for 2007. During the visits, Mr. Hofmeister holds town meetings with local residents and public officials and gives speeches about the U.S. energy situation. The results of his tour, said Mr. Hofmeister, were "sobering."

Shocked, Shocked

"I was shocked," said Mr. Hofmeister, "at how many people actually believe in the Peak Oil theory." Was he really shocked? Or perhaps he was, as the inspector of police noted in the movie Casablanca when he learned that people were gambling in a certain saloon, merely "shocked, shocked."

Shell's Mr. Hofmeister cannot be unaware of Peak Oil theory. The Peak Oil theory was, after all, pioneered in the 1950s by a geologist named M. King Hubbert (1903-1989), who worked for none other than Shell. It is not quite like the guy who runs General Electric dismissing the import of Thomas Edison or the development of the light bulb, but it is in the same ballpark.

Shell's geologist Hubbert based his Peak Oil concept on the rather obvious point that you cannot extract oil that you have not discovered from the ground. So Hubbert reviewed mountains of data concerning oil discoveries, and oil extraction and production, dating back as far as the 1860s. Hubbert noted the common trend in oil field development for a new field to come online and oil production to increase as the field was drilled and developed. But then, over time, the inevitable effects of depletion would kick in and cause the overall production of the oil field steadily to decline.

Hubbert's Curve

In the days before sophisticated computers and elaborate spreadsheet programs, Hubbert crunched his own numbers. He cumulated the reserve figures for oil discoveries in the U.S. and the production histories of thousands of U.S. oil fields dating back almost a century. Hubbert observed and demonstrated, through a process called "reserve backdating," that most major oil discoveries in the U.S. had occurred by the 1930s. That is, even though reserves may not have been listed on a company's books until much later, they were, in geological fact, part of the original discovery many years before. And Hubbert focused on the point that after the largest oil fields had been discovered, in terms of both surface area and volume of calculated reserves, the "new" discoveries thereafter tended to be smaller oil deposits, or extensions of previously discovered oil fields and oil-bearing trends:

In a paper that he prepared and delivered in 1956, over the objection of several Shell executives, Hubbert postulated that total U.S. oil production would increase until about 1970 and then reach a "peak," from which it would then steadily decline in volume over time:

Hubbert updated his 1956 predictions in the early 1960s and came up with essentially the same forecast of U.S. oil production peaking by 1970. Hubbert did not anticipate the 1968 discovery of the oil field at Prudhoe Bay, Alaska. But his numbers were prophetic, and eerily accurate, for the lower 48 states. Almost on cue in 1970, overall U.S. oil production peaked and commenced its long trend of irreversible decline, barely changed even by the development of Prudhoe Bay in the 1970s. Thereafter, the U.S. has imported more and more conventional oil to meet its daily needs:

So the discovery side of Peak Oil theory holds that mankind has identified and located, if not actually discovered, most of the conventional crude oil that there is to find in the crust of the Earth. The production side of Peak Oil theory holds that mankind has produced, and, of course, consumed, something near half of it. In terms of really big Peak Oil numbers, out of a worldwide resource base of conventional oil that is estimated by some knowledgeable commentators at about 2.2 trillion barrels, about 90% has been discovered and about 1 trillion barrels have been extracted and consumed over the past 150 years or so.

Bell-Shaped Curve

Mathematically, the history of oil production in any given region is a bell-shaped curve, with "tails" on each side and a relatively rounded top in between. In a very general sense, the initial increase of the first half of the curve is mirrored by the decline phase on the other side. It is like saying that "what goes up must come down," but it is all rooted in the concept that you cannot produce what you have not discovered.

Applying Hubbert's methodology to the global resource base, the world's oil industry currently appears to be at the top of the Hubbert curve. Each day, the world's oil industry is pumping the known oil reserves out of the crust of the Earth at a rate of about 1,000 barrels per second, or 85 million barrels per day, or about 31 billion barrels per year. And the global economy is consuming or otherwise burning up almost every drop of that oil. (Some very small fraction goes into storage, such as for the Strategic Petroleum Reserve of the U.S. or comparable reserves in other nations such as China. This oil, too, will eventually be burned or otherwise consumed.)

The balance between global supply and demand is precarious, such that if just a couple of hundred thousand barrels per day of production (near a rounding error from a production base of 85 mbd) go offline, there can be significant price moves, as occurred last August when BP closed the Alaska pipeline. Or consider what the traders call "political risk," such as the result of hostilities closing a maritime control point such as the Straits of Hormuz. If even one oil tanker were to, say, hit a mine in the Persian Gulf, oil prices would skyrocket within hours.

The Edge of Secure Supply

Shell's Mr. Hofmeister knows all of this. At a recent speech he gave in Pittsburgh, for example, he began his talk with a rather gripping story that dealt with the supply of refined product, as opposed to crude oil. But the story illustrates the point.

According to Mr. Hofmeister, in the aftermath of hurricanes Katrina and Rita in 2005, almost all of the U.S. Gulf Coast refineries were down due to flooding and other storm damage. Shell had 300,000 barrels of refined product in storage at its Baytown, Texas, refinery, which was essentially the only supply available to the entire U.S. Southeast region, but there was no electricity with which to run the pumps. Whoops!

Shell employees and contractors were working feverishly to rig up electric generators at the Texas facility, but it was a race against time, over a 48-hour period, until the Plantation and Colonial pipelines -- - the major trunk carriers for refined product between Texas and the Southeastern U.S. -- went dry. If word escaped of the predicament, Shell executives believed that many members of the consuming public would have panicked. Then panic-buying would have immediately kicked in and rapidly drained whatever fuel was left in the supply system. The entire Southeast, home to about 60 million souls, could have been caught in a situation in which there was be no fuel available anywhere. It fell to Shell's Mr. Hofmeister to call the U.S. secretary of energy and deliver the bad news.

But like the cavalry arriving near the end of a John Ford Western, Shell's hardworking people hooked up the Texas facility with electric power, with all of about 12 hours to spare. Shell started pumping gas into the pipeline system. There were, you may recall, spot shortages of fuel in the Southeast, but no regional lack of product. Still, as Mr. Hofmeister put it, it was a close call and the U.S. was and remains "on the edge of secure supply."

Same Thing With Crude Oil

Mr. Hofmeister's story concerned gasoline, but he could have told the same story with respect to crude oil or natural gas. The Gulf of Mexico hurricanes of 2005 wrecked oil and gas production facilities all along the littoral, to the point of toppling over offshore structures that are the size of World War II aircraft carriers. The hurricanes churned the water column down to the seafloor, and ripped up or displaced underwater pipelines, subsea production equipment, and much else of the Gulf Coast oil infrastructure on which the U.S. relies for energy supply. In addition to the damage to property, tens of thousands of members of the oil industry work force were displaced from their homes and job sites by hurricane damage. The Gulf Coast oil industry still has not recovered, 18 months later.

So yes, "we are on the edge of secure supply" from prospect, to drill bit, to pipeline and refinery, to the gas pump. And a lot of people are starting to figure that out and think about it.

Peak Oil theory is one way of making sense of quite a bit of what goes on in this world, beginning with the supply of conventional crude oil and with implications for the rest of the energy mix of the world's advanced industrial societies. There is a certain geological coherence (even elegance) to the idea of Peak Oil, and a mathematically demonstrable basis to the concept.

So it should not "shock" anyone, let alone the president of Shell Oil Co., that "many people actually believe in the Peak Oil theory." In fact, I think that Peak Oil theory makes Mr. Hofmeister's job easier. Once people understand the key issue behind the nation's energy supply, it is more probable that they will be willing and able to design a solution.

Until we meet again...
Byron W. King

for Whiskey and Gunpowder

Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.