A blown call – global oil and gas production industry is indeed fully up to meeting future demand growth

Predicting what will or will not happen in the future is generally not the wisest thing to do, because random events and developments create eternal chaos, but we all fall off the wagon sometimes. Doing so requires, at some point, being ready to eat your words when reality fails to heed my advice and does whatever it wants. And there is no better time for word-eating than in the heart of summer when many are on holidays. It beats making retractions in size 4 font, which is the lowest-grade yet least unpleasant alternative for any street smart but humiliated prognosticator. So, here we go. My turn.

I’d pretty much actually forgotten about this one particular bad call, but then about a year ago, speaking at an event, someone asked me if, looking back at my book that came out in 2019, whether there was anything in it that I had gotten completely wrong. It was a very good question, and, coming live from the floor, it caught me flat-footed, because six years is a long time and I said a lot of stuff. I mumbled something like “I don’t think so” because my CPU was not capable of reprocessing all the topics in a timely manner, standing there with several hundred people staring at me awaiting a response. It would have been too weird if I had played the odds and said Yes, I did get some things wrong, but I don’t remember what they were. That would be even worse for the credibility.

The question sat front and centre in my brain for some days, because I knew my response was probably wrong and should have been better answered with a vigorous coughing fit instead, followed by a deft pivot to another topic. That’s what any good weasel would have done. But I am not a good weasel, quite a bad one, and was not quick enough, and now that I’ve had time to think about it in better detail, it is time to come clean on at least one blown call.

In the book, I hypothesized that the hydrocarbon industry would have trouble meeting forecasted growth in energy consumption. At the time, global oil production was approaching 100 million barrels per day, and some demand forecasts had the global call rising to 110 million b/d. I commented that, in a world poked full of exploratory holes, it was going to be hard to impossible to add another Saudi Arabia’s worth of production. While we aren’t at that level yet, it is quite clear that the industry is quite capable of doing so.

That forecast of a production ceiling was a bad call, because we are halfway there and the world shows no signs of being tapped out. Some in the energy sector immediately disagreed, and they were correct. A bad call is a bad call, and there is no point deflecting that fact anywhere else, but it is helpful to revisit why it it turned out to be a flawed argument or prognostication. Well, maybe it doesn’t help you, but it helps me.

Two factors, at least, have changed that have proven my thesis incorrect. Or rather, one has changed, and one has gotten so glaringly large that it cannot be ignored.

The first factor that has changed is the world’s attitude towards hydrocarbons. In 2019, an army of activists, including Canada’s very own then and current prime ministers (and no, I will never miss a chance to mention that), were at the forefront of a move to starve the hydrocarbon sector of financing, insurance, and market options. Oil and gas production was being stymied everywhere, which was one reason I started forecasting numbers like a garden-variety fool.

Times have changed. Since then, a powerful tide of sentiment has swept across most continents that values energy security above almost all else. Or perhaps it is more accurate to say that energy security has always been prized, but that now people have a better realization of what that means as opposed to what governments and special interest groups tried to ram down their throats – that a rapid energy transition was inevitable. Given the stature of those making such claims, the general public shrugged and largely went with that flow, because no one cares about where stuff comes from. Until it doesn’t.

Anyone but the most ideologically blinded can now see how crazy that idea actually was, and yet it was everywhere. Even oil industry executives pickup the chant, bizarrely signing up for the movement that would have destroyed their own business within a few decades, and, worst of all, they had to have known it was malarkey. But such is the pressure in the limelight. The Emperor’s New Clothes is a very old tale, and still wildly accurate. A great many oil industry executives and insiders disagreed, but were afraid to say so publicly, which is kind of terrifying, because it is fuel we are talking about here. The mob moved against hydrocarbons, hard, and people could pay a very big price professionally for voicing the wrong opinion. Mercifully, that environment has changed. It is ok to speak of energy reality again. And so it is also easier to speak of building pipelines, and drilling wells, and constructing energy infrastructure. Such was not the case 6 years ago, which was one of the reasons I could not see production increasing materially in the future.

The second factor that has not just changed but become very obvious is the formidable skill set of the energy industry, one that continues to reinvent itself and get better at what it does. In my book, I pointed out that hydrocarbon exploration was becoming more difficult as the finite globe is understood more and more, that much of the world has been tested for hydrocarbons, and that a globe has only so many new places to discover. That part is true, but what wasn’t true in my hypothesis was that technology and recovery factors would top out, in a world that was trying to deconstruct the hydrocarbon industry. Producers just get better and better and better, and the lessons learned can apply all over the world. In 2019, I totally underestimated that factor.

We are witnessing this industry’s strength in this regard live before our eyes, here in Canada, as a new technological development called open hole multi lateral (OHML) drilling cracks open reserves in established fields that were known about but weren’t economically recoverable. OHML drilling is a twist on regular horizontal drilling, but as opposed to one lateral well bore (which is usually fracked), OHML drills multiple laterals from the same vertical wellbore. This process has been made possible largely by new drilling technology that allows precise measurement of the bit, and where it is going, during drilling operations. Operators are taking this new technology and revisiting many old fields, and greatly increasing output. The potential market for this new technology, globally speaking, is vast.

Beyond OHML, drillers continue to refine the fracking process, making it more efficient and productive. More and more oil/gas can be extracted from fewer wellbores, which can accelerate production and increase recovery factors.

And so, technology advanced in ways I had not foreseen, which was probably somewhat predictable in hindsight – that technology would continue to improve.

On that last point, there is another related factor that I underestimated, or failed to appreciate thoroughly – the value of existing infrastructure. It’s kind of shocking to say that, because my appreciation for infrastructure knows no bounds, to the point that it is a little unnerving. But as it turns out, existing infrastructure entirely changes the landscape of what is possible and profitable.

Consider Appalachia gas, which I had considered to be on the verge of tapped out as all the sweet spots have been exhausted by 15 years of drilling. And it is true, those sweet spots are quite well developed. However, the gas on the fringes of the sweet spots is readily accessible via built in pipelines and lease sites and so the cost of adding incremental production is relatively low – and those reserves would not likely have been tapped if entirely new infrastructure had to be built to access them. Keeping volume up keeps pipelines full and unit costs down, so it makes sense to keep production flat at some seriously low prices, because of that old accounting nugget called “contribution margin”.  There are many ways to describe it, but the concept is that as long as a new unit of production is cash flow positive and contributes to fixed system costs, it makes sense to keep adding.

In this way, a handful of operators can keep production flat at a staggering 35 BCF/d with about 30-40 rigs. Can they do this forever? No. But they can do it for a long time from here. And each time oil or gas prices rise to a new level and stay there for a while, producers will get to work on ‘marginal acreage’, or second-tier rock, or whatever you want to call it – accumulations of hydrocarbons that are inaccessible now, but might become so if the price rises high enough. A wise old geologist once told me, “I can’t show you any $30 oil, but I can show you a lot of $300 oil.”

The thesis that we will eventually shift away from hydrocarbons in some sort of energy transition may well be correct, but my timeframe was way off, by, it looks like, a century or two. And this could be incorrect yet again, depending on how successful new energy technologies come to fruition, and how fast. But that rate of change may be tied to the energy sector’s rate of change in hydrocarbon development. If the oil and gas sector’s technological improvements continue at a rapid pace, oil and natural gas price levels will remain at affordable levels and it will be harder for new technology to replace them. However, if there are fumbles, either above or below ground that cause oil and/or natural gas prices to go to a much higher level for a prolonged period, then the incentive to develop something else, and the potential reward, will be greatly accelerated. We can see inklings of that now with the renewed love for energy security; this consciousness is now accelerating development of nuclear technologies in ways not seen before.)

But any new technology, in order to be truly transformative, has to be not just vastly better, but so good that its advantage can swamp the advantage that existing infrastructure provides.

And so, good lady at the conference that asked me the question, I’m sorry that I gave you an incorrect answer, at least in this regard. You may wish to rip out that chapter. No refunds though.

In summary, I have no idea what the upper boundaries of oil or natural gas production are, globally. Forecasting that joins the other mugs’ games of predicting commodity prices and energy transition timelines. Nothing is as humbling as taking a stab at that.