OilVoice Magazine - September 2014

Edition Thirty September 2014
Making sense of the US oil story

Is big oil gearing up for mega-mergers?
North Sea Oil and Scottish Independence: where does the truth lie?
Cover image by DVIDSHUB

1 OilVoice Magazine | SEPTEMBER 2014

Issue 30 September 2014
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Adam Marmaras
Chief Executive Officer

Welcome to the 30th edition of the
OilVoice Magazine.

Were always tweaking the OilVoice
website based on feedback from our
dedicated readers. This month we
made changes to the layout of our
article pages, making it easier to digest
the latest oil and gas news.

This month we have great articles from
ABT Oil & Gas and RMRI, and Mars
Omega. We'd also like to welcome
back some of our regular authors,
including Gail Tverbeg, David
Bamford, and Mark Young.
If you're interested to know more about
seeing your articles featured on
OilVoice, please get in touch.

Adam Marmaras
CEO
OilVoice

Contents

Featured Authors
The biographies of this months featured authors
3
Tech Talk - Rig counts in the Middle East
by David Summers
5
Lifting sub-surface interpretation into the second decade of the 21stC!
by David Bamford
8
Making mature petroleum provinces economic
by David Bamford
10
Using clusters as a regional development strategy for marginal fields in
the North Sea
by Chidozie Ewuzie & James Fox
14
Is big oil gearing up for mega-mergers?
by Loren Steffy
19
US companies benefit from move from natural gas to oil production
by Mark Young
21
The strange case of US confusion over Kurdish crude
by Anthony Franks OBE
26
When "common sense" really amounts to nonsense
by David Blackmon
31
North Sea Oil and Scottish Independence: where does the truth lie?
by Euan Mearns
33
Making sense of the US oil story
by Gail Tverberg
40

Featured Authors

Chidozie Ewuzie & James Fox
ABT Oil & Gas and RMRI
ABT Oil and Gas (ABTOG) is creating a new marginal field sector within the
oil and gas upstream market: the economic development of small or stranded
hydrocarbon accumulations.

RMRI is an independent, risk management consultancy delivering bespoke
decision making support for over 20 years.

Mark Young
Evaluate Energy
Mark Young is an analyst at Evaluate Energy.

David Summers
Bit Tooth Energy
While one of the founders of The Oil Drum, back in 2005, he now also writes
separately at Bit Tooth Energy.

Anthony Franks OBE
Mars Omega LLP
Anthony is responsible for managing and controlling the extensive information
networks, as well as directing and working with the analysis team to create
reports for clients, and also works with Hamish in the Liaison and Mediation
service.

David Blackmon
FTI Consulting, Inc.
David Blackmon is managing director of Strategic Communications for FTI
Consulting, based in Houston.


Euan Mearns
Energy Matters
Euan Mearns has B.Sc. and Ph.D. degrees in geology.

Gail Tverberg
Our Finite World
Gail the Actuarys real name is Gail Tverberg. She has an M. S. from the
University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty
Actuarial Society and a Member of the American Academy of Actuaries.

David Bamford
Petromall
David Bamford is a past head of exploration and head of geophysics at BP,
and a founder shareholder of Finding Petroleum.

Tech Talk - Rig counts
in the Middle East

Written by David Summers from Bit Tooth Energy
In recent posts about the situation in the Middle East, I have noted the need for
Aramco to increase the number of drilling rigs that it must use, since it is now looking
for natural gas in their tight sand deposits rather than finding the large reserves that
they had hoped in the shale reservoirs. It is interesting in this regard to plot the
number of rigs that have been working in the Middle East.

Getting the overall data from Baker Hughes the rig count can be plotted, over time,
to give the following:

Figure 1. Rig Counts in the Middle East (Baker Hughes)

If one looks at the trend for the last twelve months, it has remains on a fairly
consistent upward trend, following that of the longer time interval plot of Figure 1.

Figure 2. Recent trend in Middle East Rig count (Baker Hughes)

Back in the days of The Oil Drum, Euan Mearns and I had this concern, which
occasionally surfaced, about these numbers. From my early post on the subject
which noted that back in 2005 the KSA were running around 20 rigs, which would not
be enough to get them the production they were claiming to need in the future, to
Euans in 2011, the topic was revisited regularly over the time that the count steadily
mounted as the Kingdom had to drill an increasing number of wells just to keep
production at around the same overall level.

I am using the KSA as the example, given the large volume of its production relative
to that of the others in the Middle East, but as the numbers show, the trend toward
increased drilling rate to create enough productive wells to sustain production as the
larger volume wells dry up is starting to become a steadily more frantic race across
the region.

Rune Likvern used the phrase Red Queen in discussing the overall long-term need
of the companies in the Bakken to have to drill an increasing number of wells, with
individually reducing production, in order to remain in place with regard to overall
production. As the production from the Bakken now exceeds a million barrels a day it
may seem foolish to be predicting this squirrel cage view of the future, but the rig
count up there is still running at around 190 rigs, which is not enough to sustain
future growth for long, given that access to the sweet spots is limited, and they are
beginning to run out of new sites.

So it is in the Middle East. The rig count numbers are mounting steadily, it is
reported that there were 88 rigs drilling in the country in October 2012. Last year this
rose to 170, and the number is expected to rise to 210 by the end of this year.

Aramco have done remarkably well, over the past decade, in developing new
technologies to harvest the attic oil left around the tops of the major producing
formations such as Ghawar, as the main body of the fields begin to be exhausted.
But the problem with these secondary rig operations is that they were directed at the
smaller pools around the field, rather than tapping into the major volume, and thus
they had an expected and finite life. That life is starting to come to a close. Just as,
when sucking a thick milk shake through a single immovable straw, when it stops
drawing fluid, there is still a fair amount left in the cup. But as you move the straw
around and slide it up and down the sides, the amount that you recover gets less,
and it takes greater and greater effort to get it, to the point where you quit and
discard the carton. And that is where the Middle Eastern oilfields are beginning to
find themselves.

The high-quality light oils of the mainland are rapidly running out, and the remaining
fields with the promise for sustaining Saudi production at around 10 mbd for the next
few years, are the heavier sour crudes from the offshore fields such as Safaniya and
Manifa. At the same time there is a need to reduce the increasing amount of oil (now
at 3 mbd) being consumed in country, with the hope that this can be replaced by
domestic natural gas. But those hopes are being reduced as the shales are found to
be less productive than anticipated, and hopes are now switching to the slower
production that can, hopefully, be achieved from the tight sands but at the cost of
an increased number of wells, inter alia.

This is the writing on the wall for global oil production, and in the short-term it will be
neglected. Increasing the number of rigs will, in that interval, increase the number of
wells that will produce, even though the volume from each well will be less, and the
overall life of the wells will similarly reduce, as higher production techniques tap into
smaller fields.

But we are now on the treadmill in the squirrel cage, or, as Rune would have it, we
have wrapped ourselves in the cape and crown of the Red Queen, and must run
faster and faster just to stay in place. (There are additional concerns since, as an
example, Manifa could not be brought on line until there were refineries built that
could process that crude, and so the options for increasing production beyond the
capacity of refineries to absorb that increase is a futile exercise).

There will soon come a time when the gain from the overall increase in new wells will
not match the decline in production from older wells, particularly if the effort to run
faster is restricted to only a few players (Russia for example is not yet putting the
effort and investment into increased drilling rates in order to sustain their overall
levels of production, and given the age of their major fields are likely now in terminal
decline).

Ouch!

View more quality content from
Bit Tooth Energy

Lifting sub-surface
interpretation into the
second decade of the
21stC!

Written by David Bamford from PetroMall
Despite continuing high oil prices, mature producing provinces continue to be
challenged by poor economic returns. In part this is due to exponentiating costs. In
part it is due to the failure of oil & gas companies to grow reserves, whether by:
Exploration for new fields
Exploitation of existing discoveries
Reservoir Management of recently developed fields
Deployment of IOR/EOR technologies.
And yet we have a multitude, a wall, of new types of data that in principle allows us
to better describe prospects and discoveries, and to better describe and monitor
producing fields. Assuming we can integrate all these multi-measurements and
that is a big assumption perhaps we need to move our subsurface analysis and
interpretation beyond the LCD provided by IT-department approved, commercially
available, work stations? It simply cannot be or cannot allowed to be true that the
hardware and applications that we see on the vast majority of sub-surface folks
desks today represents some sort of apogee of digital technology. Compared with
most other digital technologies whether video games, weather forecasting, sports
punditry, financial trading most of our sub-surface interpretation tools have been
parked by our IT Departments and the supply behemoths back in the latter days of
the 20th Century, not the second decade of the 21st!
My observation is that we have two choices:

1. Machine-led analysis aka Analytics.
2. Team-led interpretation via Visualisation.
and that maybe this is actually an and conversation rather than an or one.

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Making mature
petroleum provinces
economic

Written by David Bamford from PetroMall
One view of the UKCS and NOCS is that as exploration discoveries get smaller
and/or more complex, they become uneconomic, in some companies minds
condemning the whole region.

However, recent history shows that such an analysis is too simplistic and that
provided a single operating entity can control enough resources, then the key
parameter is cost/boe and good economics can result from such an operators twin
approach of finding more resources/reserves and reducing the costs of proving and
producing them, by benefitting from scale and synergies, supply chain optimisation
etc.

This figure illustrates some of the levers available:

Most of these levers require the adroit application of technologies, more often than
not digital technologies; lets consider each of them in turn:

Exploration

It is easy to argue that NW European exploration in the NOCS, UKCS and onshore
is now so Mature that further significant, economic discoveries should not be
expected.

However, we simply do not know whether there are new plays to be tested and
significant new discoveries to be made because the underpinning work has not been
done.

In particular, the petroleum potential of NW Europe has not been assessed by
drawing together a detailed chronostratigraphy, global geodynamics and all available
public data, from wells, outcrops, publications, maps etc.

This problem is entirely solvable by the techniques of Gross Depositional
Environment & Common Risk Segment mapping.

Exploitation

There has been no area-wide review of undeveloped discoveries nor of known but
non-completed reservoir intervals.

Here the key will be more sophisticated attribute analysis of existing mega-3D
surveys, integrated with a profound understanding of rock physics.

Reservoir Management

Reservoir dynamics can be far, far better understood by monitoring fluid movements
with seismic, fibre optics, flow meters etc, and integrating this factual data with
improved, faster, reservoir simulation honouring geomechanics.

This leads both to improved recognition of reserves and therefore production, at the
same time lowering costs because well locations and completions have been
optimised.

IOR/EOR

Too many companies are content with field recovery factors that settle between 30
and 40% whereas technology can take us to 60%+.

A wide range of technologies are now available from Smart Water via WAG to CO2-
enabled EOR.

Drilling & Completions

Rig costs are the prime driver of oil patch cost exponentiation, and are too
controlled by a small handful of companies.

We need to promote competition in NW Europe, and promote cheaper options such
as coiled tubing drilling and even cheaper options such as wireline tractors, for well
intervention and completion. Technology options include sending real time drilling
data to shore to improve decision making, ultimately leading to unmanned (safer,
cheaper) drilling.

Digital Oil Field (DOF)

Integrated Operations - DOF technologies - are the way to run fields efficiently and
effectively, removing personnel from the production environment (safety), optimising
production, reducing costs.

And finally...

It is not helpful for politicians and civil servants to give lectures about cooperation
and collaboration perhaps they would do better to set us all an example!

Regional Operating Entities (ROEs) need to control big swathes of acreage,
covering enough reserves to enable economic development; having 500mm to 1bn
boe reserves under the control of one ROE would seem to be the right scale. This
requires industry consolidation.

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Using clusters as a
regional development
strategy for marginal
fields in the North Sea

Written by Chidozie Ewuzie & James Fox from ABT Oil & Gas and RMRI
The UK North Sea is a mature basin with an extensive and well-developed network
of production infrastructure consisting of platforms, pipelines and onshore processing
plants and terminals. The basin has so far produced around 42 billion barrels of oil
equivalent (boe), and it is estimated that up to 21 billion boe could be further
produced
[1]
. Over the past four decades, this production capacity has been built up
using 'daisy chains' of infrastructure that was originally installed to support large
offshore projects, but which has since unlocked new opportunities. Each cluster of
fields typically started out with a single, large, field development in a fallow area,
such as the Forties and Brent fields in the 1970s. To maximise economies of scale,
exploration activities were then concentrated around these massive oil and gas fields
and often led to new discoveries and prospects being found. Large fields were
developed with above-surface infrastructure while smaller and more marginal
discoveries were often then developed via subsea tie-back to existing host facilities,
receiving terminals, or other subsea infrastructure which acted as a hub for
development of the area. These small fields required a low cost development to be
commercial, hence the option of tie-backs. This pattern has been repeated over
several years, aided by high oil prices, resulting in the growth of infrastructure and
production in the basin.

However, production efficiency of oil and gas fields across the UK Continental Shelf
(UKCS) has declined from 81 per cent in 2004 to its current level averaging below 60
per cent
[2]
because the production facilities are experiencing more frequent and
longer outages as they age and many are now operating beyond their design life.
This has largely contributed to the 63 per cent fall in oil production over the same
period
[3]
, costing the Treasury 6 billion in lower tax receipts
[4]
. The maintenance
procedures necessary to keep these ageing assets operating safely in order to
extend useful life is cost intensive ensuring they have very high per barrel operating
costs. This upward pressure on costs makes it more difficult for operators of smaller
fields to negotiate satisfactory commercial tie-back arrangements with infrastructure
owners. As such, infrastructure in mature areas in the North Sea is under increasing
commercial pressure as maintenance costs increase and throughput diminishes
[5]
.
The Wood Review notes that the pace of new developments is being constrained in
part by the inability of third parties to negotiate appropriate technical and commercial
terms to achieve access to existing infrastructure. As a result, developments are
taking longer to implement and often end up being sub-optimal
[6]
.


A New Development Model

A massive investment in existing production infrastructure is required to maintain
safe and reliable operations and increase production, however, declining production
income makes it difficult to support such levels of investment. Therefore, a shift in
approach is necessary to facilitate an evolution in the design of low cost production
systems that can be independent of ageing facilities. In our earlier article, we
introduced two such production systems developed by a British company, ABT Oil
and Gas Limited (ABTOG), along with its partners the Production Buoy and Self-
Installing Floating Tower (SIFT). These are cost effective, mobile standalone
production systems suited for use in marginal field developments which are capable
of redeployment and can be independent of existing infrastructure. These systems
have the added advantage of reduced reliance on expensive installation vessels,
simplified project delivery, and can operate normally unattended.

The SIFT is an offshore oil production facility capable of multi-field processing which
primarily targets oil and gas fields within 50 150 m water depth, ideally suited to the
North Sea. It has a design life of 25 years, is redeployable, and can be remotely
operated as a Normally Unattended Installation (NUI). It is comprised of structural
columns that are fixed via the foundation to the seabed. The structural columns
support multipurpose topsides which contain the necessary process, utilities and
ancillary facilities required to process the well fluids. The crude oil is stored within the
structural columns and additional oil storage cells can be located between the
structural columns. The crude is then transported to a terminal via periodic shuttle
tanker visits; hence the system can be independent of local infrastructure.

The Concern over Decommissioning

As larger fields are depleted and production facilities are abandoned and
decommissioned, this will have an adverse effect on future production in the basin.
The loss of strategic local infrastructure as the daisy chain fragments will remove a
primary means of oil production in the basin leading to more stranded small and
marginal fields.

The Wood Review sets out a decommissioning strategy that aims to achieve the
maximum economic extension of field life and to ensure key assets are not
decommissioned prematurely to the detriment of production hubs and infrastructure.
However, many of these assets are already past their design life and therefore
decommissioning, whilst being possibly delayed, is inevitable. In the UKCS, there
are several critical hubs at risk of decommissioning. The current course of action
places at risk billions of reserves that could be left stranded and extending the useful
life of existing assets is cost-intensive. With the ABTOGs low cost production
systems, there is an opportunity to avoid such risks and reframe how mature basins
are exploited.

Decommissioning will also have a significant impact on exploration and future
discoveries. Exploration activity is declining rapidly as the size of discoveries
continue to reduce and this coupled with ageing infrastructure in the basin does not
create a conducive environment for the sanction of multi-million pound investments

that could be deployed anywhere in the world.

The maturity and decline of the North Sea means that decommissioning activities will
be ongoing at different hub locations for the remainder of the North Seas productive
life. Hannon Westwood estimate that by the 2020s the areal coverage of active hubs
may shrink to less than 50 per cent of the area containing prospects or discoveries
and some 3 billion boe would remain unassigned to hubs and would require either
standalone development or extended connectivity to existing hubs
[7]
. As such, what
is required is a focus on proven standalone production systems which can be
independent of existing infrastructure and also capable of providing a commercial
development for small and marginal fields, thereby maximising recovery and
extending the life of the basin. Therefore, given the emergence of ABTOGs
production systems, the current concern over decommissioning is somewhat
misplaced.

The Development Potential

Figure 1- Map of a cluster of marginal fields in the North Sea

In this report, we have set out to demonstrate an alternative model for the
development of a cluster of marginal fields in the North Sea using a SIFT. To
illustrate this model, we have modified data from the central North Sea (CNS) where
we identified a cluster of five marginal discoveries and end of life fields in a 25 km
radius, all located in 100 110 m water depths and within the operating envelope of
the SIFT. A map of the area is shown in Figure 1 above. Two discoveries within this
group are stranded by distance (~ 19 km) and insufficient processing capacity at the
nearest platform which is due for decommissioning in around 5 years. Another two
are closer to the fixed platform but have been held back by inability to finalise a
commercial agreement for a tie-back. The final one is an end of life field due to be
stranded when the nearby FPSO is removed. The total mid-case reserve size for all
five fields is 25.6 million boe. The end of life field at 3 million boe can be developed
because the cost of the SIFT has been amortised over the production life of the first
two fields to be developed, therefore the major capital expenditure associated with
this field is the well re-entry cost. This unique advantage of the SIFT enables the
economic development of minute reserves and therefore maximises economic
recovery of the basin. A map of the sequence of development of the fields using a
SIFT as a hub or enabler is shown in Figure 2 on the next page.


Figure 2- Map showing the sequence of development of the cluster area using the
SIFT as a hub

To see what can be achieved by this development scenario, a cashflow model was
developed to evaluate the development of marginal fields in this cluster area. The
development is split into three phases. In the first phase, the SIFT is deployed to the
first stranded field and after two years of production, the second stranded field is
tied-in. At cessation of production (COP) after six years, the SIFT is retrofitted for a
year and redeployed to the mid-point of the two discoveries close to the fixed
platform to be decommissioned. These will be developed simultaneously and
produce for six years before COP, and then the SIFT is retrofitted again and moved
to develop the end of life field using existing wells. Eventually, 25.6 million boe of
reserves is produced from all five fields over 20 years from project inception to
abandonment.

With oil prices fixed at $90 per barrel and ignoring the impact of inflation, the entire
project has a pre-tax NPV10 of 365 million and generates gross revenue of close to
1.5 billion with a combined capital and operating expenditure of approximately 650
million. The project as a whole therefore generates a pre-tax profit of close to 800
million. Taking deductions such as the small field tax allowance, we estimate the tax
revenue to be almost 390 million and therefore the post-tax profit is over 400
million. This equates to almost 16 of post-tax profit per boe and 15 of tax revenue
per boe.

We have identified over 120 marginal fields in the North Sea which could be
developed using a SIFT and we estimate that it would take between 20 30 clusters
such as the one described above to develop these fields. If we assume that all the
fields are developed, the potential worth to the UK economy is estimated to be in
excess of 37 billion; over 19 billion of post-tax profit and 18 billion of tax revenue.
While we estimated the contribution to the UK to be in excess of 40 billion in our
earlier study, the cluster model is simply one way of unlocking marginal reserves and
therefore this is consistent with our earlier results.

Summary and Conclusion

The conventional view of marginal field development assumes that as critical
infrastructure is lost, tie-backs will become increasingly difficult to implement and
less cost effective. Higher costs will lead to medium sized fields becoming marginal

and small fields becoming sub-commercial. Also, with fewer production hubs
available, the basin will continue to decline as the means of production is lost. As
such, developing marginal fields in the North Sea has been described as a race
against time
[8]
. This view is mistaken and now outdated as the standalone systems
introduced by ABTOG have the dual benefit of utilising pipelines and existing
infrastructure if available or acting as a standalone production system if necessary.

The joint industry government task force PILOT estimates that between 0.5 2
billion boe
[9]
of reserves are at risk from the early decommissioning of existing
infrastructure while industry experts Hannon Westwood estimate the overall potential
loss in reserves due to loss of infrastructure is around 7 billion boe
[10]
. These
reserves that were thought to be at risk from decommissioning and soon to be
stranded can now be commercially recovered through the use of ABTOGs
production systems. Improved data sharing, collaboration, greater third party access
and fairer commercial and technical agreements for access to infrastructure are all
valuable ideals, but it is debateable how these will be achieved in a highly
competitive environment, even with a newly constituted and empowered regulator.
Therefore, independent, standalone production systems such as the Production
Buoy and SIFT are the right solutions.

ABTOG's solutions present a viable means of developing marginal fields in the North
Sea with or without the use of existing production and process facilities. These
systems can also be applied to marginal or end of life fields in other regions where
access to existing old infrastructure is not viable or simply not available. The UK
could benefit via technology and knowledge transfer as these production systems
are engineered and built in the UK and can exported to other regions to the benefit of
the wider UK economy. In subsequent studies, we will further explore this
opportunity.

[1]
http://www.gov.uk/oil-and-gas-uk-field-data#uk-oil-and-gas-reserves
[2]
PILOT presentation, 31 October 2013
[3]
http://www.gov.uk/government/collections/digest-of-uk-energy-statistics-dukes
[4]
Comparison of UKCS Tax Yield Budget 2011 and 2013
[5]
UKCS Maximising Recovery Review
[6]
ibid
[7]
Hannon Westwood hub analysis presentation, December 2011
[8]
J. Harpin (2011). Measuring the impact of aging infrastructure in the UK North Sea
[9]
PILOT presentation, 2 May 2013
[10]
See reference 7

ABT Oil & Gas and RMRI

Is big oil gearing up for
mega-mergers?

Written by Loren Steffy from 30 Point Strategies
Big Oil may once again be getting ready to eat its own. The Guardians Ben Marlow
raised the prospect once again this week, exploring the idea that Royal Dutch Shell
might be warming to the idea of a merger with BP.

For the past several years, one of the biggest questions among the majors is what
happens to BP. The companys shares have never recovered from the Deepwater
Horizon disaster in April 2010. BP has sold $38 billion in assets to pay the ongoing
legal costs, and it has set aside $42.5 billion to cover the cleanup, fines and other
costs related to the worst offshore oil disaster in U.S. history.

In October, it announced plans to sell $10 billion in additional assets, this time
earmarking the proceeds to boost shareholder value. It also reinstated the dividend it
cut after the accident.

Just as things were beginning to improve for BP from an operating standpoint, the
company warned that economic sanctions against Russia could post a threat to its
holdings there. BP owns 20 percent of the Russian oil company Rosneft , and the
payments it receives from the Russian company accounts for one-tenth of its
operating income.

In addition to the sanctions, Rosneft could be affected by a pair of European court
rulings this week in which the Russia government was found liable for seizing the oil
company Yukos a decade ago. The decisions, which combined awarded almost $53
billion to former Yukos shareholders, could have implications for Roseneft, which
received some of Yukos assets after the seizure. The decisions increased the
pressure on BPs shares this week.

BPs struggles have long made it the speculation of takeover rumors. The company
has a lucrative reserve base, especially in the Gulf of Mexico, but the mammoth legal
case related to the Deepwater Horizon has served as a powerful poison pill, keeping
would-be suitors at bay. Once the full scope of the legal costs became clear, the
theory went, BP could find itself in play.

While its still not clear the full extent of BPs legal exposure, a court ruling on
criminal liability is pending and the picture could become clearer in the coming
months. At the same time, potential suitors may begin to see any additional liabilities
as less of a risk than some of the operating challenges they have undertaken
recently.
The pool of potential buyers that could afford to buy a company the size of BP is
pretty small, which is why most of the speculation revolves around Shell.

The majors have all faced a difficult environment in recent years. Exploration costs
have risen and commodity prices havent followed suit. Thats made it more
expensive for companies to replace reserves even as it forces them to look for ever
more expensive and riskier prospects to find more oil.

BP sparked the last round of industry mega-mergers when it bought Amoco in 1998.
Exxon promptly bought Mobil, Chevron bought Texaco, TotalFina bought Elf and
Conoco merged with Phillips Petroleum. Shell was one of the few majors to sit out
the deal making.

In fact, BPs then-CEO John Browne had a plan to buy Shell, but he never followed
through on it, in part because of mounting operating problems that included the fatal
Texas City refinery explosion in early 2005.

The question now is whether the deal could go the other way. Shell has faced a
series of operating setbacks. It recently abandoned its role in developing natural gas
reserves in Saudi Arabia, and it has faced persistent frustrations in efforts to explore
for oil in the Alaskan Arctic.

As Marlow points out, the current leaders of the major oil companies arent the deal
makers that their predecessors were. Whats more, they may have learned a lesson
from Exxon Mobils $41 billion purchase of onshore independent XTO Energy in
2010. It was the biggest acquisition since Exxon bought Mobil, and it was designed
to push Exxon into lucrative U.S. shale plays. But it didnt pay off for shareholders,
and Exxon CEO Rex Tillerson later acknowledged the deal was poorly timed.

Shell may have another concern. BP is a company that has suffered more than a
decade of operating failures and safety lapses because of a corporate culture that
placed incentives on profits and production over maintenance and safety. Corporate
cultures are difficult to change, and its not clear how successful BPs new CEO, Bob
Dudley, has been in fixing the problems within BP.

Still, if the current price environment persists, and the majors continue to struggle to
find the kind of returns they need through exploration, their thoughts might once
again turn to acquisitions. Even with BPs overhanging legal costs and questions
about its culture, its asset base may start to look more enticing.

30 Point Strategies

US companies benefit
from move from
natural gas to oil
production

Written by Mark Young from Evaluate Energy
The last few years have seen many of the oil and gas companies in the United
States change their strategy away from natural gas and focus on oil producing
assets due to low gas prices. Despite the steady and gradual recovery in the Henry
Hub benchmark gas price in the US since the middle of 2012, second quarter data
from a group of US oil and gas producers in the Evaluate Energy database shows
that this move towards oil production has still been very worthwhile.

Source: Evaluate Energy - The Henry Hub gas price shows a gradual increase on
average from Q2 2012 ($2.29/mcf) to Q2 2014 ($4.60/mcf) while the WTI oil price
has stayed relatively stable at around $90-$100/bbl in the same timeframe.

To show how worthwhile the strategy change has been, a group of 20 US domestic
oil and gas producing companies with market caps between $1 billion and $10 billion
have been selected. All of the companies in question were gas weighted - produced
more gas than oil - in Q2 2012. The companies in that group that have switched their
strategies to now be producing more oil than gas in Q2 2014 are shown in the chart
below. The strategy was carried out by either buying oil assets, selling natural gas
wells or by simply reallocating capital away from gas to develop oil projects instead.


Source: Evaluate Energy

The other half of the group, shown in the chart below, is still gas weighted. As 3 of
these companies - Comstock Resources, Goodrich Petroleum and QEP Resources -
have shown a distinct movement towards oil production similar to those companies
in the graph above, these will be considered as companies who have made a
strategy change as well, despite still technically being gas weighted.


In the chart below, 5 significant metrics have been chosen to show how these 2
groups of companies have fared since the second quarter of 2012. The group of
companies that changed strategy (see note 1) are denoted as oil in the chart
below, and the companies who remained natural gas weighted are denoted as gas
(see note 2). Each groups results for the 5 metrics in the graph below have been
taken from the Evaluate Energy database and averaged out for Q2 2012 and Q2
2014. The average % increase in that time for all metrics is displayed in the chart.



As you can see, whilst gas producers are doing better than in 2012, the percentage
increases for those companies who switched their strategies to focus efforts on oil
production are much greater. There is a slightly larger increase in operating
expenses associated to oil production, but this is more than offset by the increases in
other areas.

On average, revenues per barrel have increased by double the percentage of the
gas producers and the difference between the respective increases in operating
netbacks is very striking. This has also translated into higher cash from operations in
the financial statements. The market has also clearly approved of the switch to oil,
with market caps for the oil producers now nearly 70% higher than they were in
2012.

It is clear that the change in strategy has paid off for those who were able to do it.
Whilst the gas producers are better off with the higher gas prices in 2014, the move
to oil has boosted the other half of the 2012 gas weighted peer group by a much
larger degree.

Notes:

1) The companies that have changed strategy since 2012 and included in the oil
group are Bill Barrett Corp. (BBG), Breitburn Energy Partners (BBEP), Carrizo Oil &
Gas (CRZO), Energen Corp. (EGN), MDU Resources Corp. (MDU), Newfield

Exploration (NFX), Penn Virginia (PVA), SM Energy Co (SM) and W&T Offshore
(WTI). Comstock Resources (CRK), Goodrich Petroleum (GDP) and QEP Resources
(QEP) are also included in this group despite still being gas weighted, as they have
shown large movements towards oil production since 2012.

2) The companies who have remained gas weighted and are included in the gas
group are Atlas Resources Partners (ARP), EV Energy Partners (EVEP), EXCO
Resources (XCO), Magnum Hunter Resources (MHR), National Fuel Gas (NFG),
Ultra Petroleum Corp. (UPL), Unit Corp. (UNT), and WPX Energy (WPX).

This report was created using second quarter data for 20 US oil and gas companies
in the Evaluate Energy database. Evaluate Energy holds quarterly and annual
financial and operating data for 300+ of the worlds biggest and most significant oil
and gas companies.

Evaluate Energy

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further

The strange case of US
confusion over
Kurdish crude

Written by Anthony Franks OBE from Mars Omega LLP
The last 96 hours saw the US becoming apparently unthinkingly complicit in the de
facto if not de jure economic embargo of Kurdistan. This was followed by a rapid
series of political announcements by US officials denying that this was the case.

Confused? Probably not as much as the US administration appears to be -despite
denials to the contrary.

The story so far

In brief, earlier this week, the Ministry of Oil in Baghdad wrote to a US judge to seek
an order for the seizure of a cargo of crude oil - worth some $100M - sat in the
United Kalavrvta, a Marshall Islands-flagged vessel, at the time parked off
Galveston, Texas.

The Ministry of Oil in Baghdad claimed the crude was illegally produced from Kurdish
oil wells. According to a complaint filed in federal court in Houston, the Kurdistan
Regional Government (KRG) was accused of having misappropriated more than 1
million barrels of oil from Kurdistan and exported it through the Kirkuk-Ceyhan
pipeline.

US Magistrate Judge Nancy Johnson then issued an order authorising US marshals
to seize the crude cargo and store it ashore for safekeeping until the dispute was
resolved.

According to the filing (Ministry of Oil of the Republic of Iraq v. Ministry of Natural
Resources of Kurdistan Regional Governorate of Iraq et al, U.S. District Court,
Southern District of Texas, No. 3:14-cv-00249) the cargo of crude departed Ceyhan
on 23 Jun 14 and has changed destinations multiple times while at sea.

Note the Ministry of Oil call Kurdistan a regional governorate, just to cement the
canard that Kurdistan is a part of federal Iraq, even though the Kurds 1050 km
border is now largely shared with the extremists in ISIS, not federal Iraq.

The problem that Washington initially thought it faced was clearly that if it allowed a
US refinery to accept the Kurdish crude, it would in effect be saying that it is
acceptable for the US and by extension the global energy market to buy Kurdish oil,
and this ran the risk of upsetting Baghdad.


That state of affairs would then allow the wedge of oil between Baghdad and Irbil to
drive the two capitals apart. This ignores the fact that the two capitals are now further
away from each other than at any time since the fall of Saddam Hussein.

Washingtons position remains they want to see a federal Iraq, including Kurdistan
by definition; otherwise their $2T was wasted - and the more than 4486 dead and
over 32,000 wounded US servicemen will have fought for nothing.

The US all at sea

Back in Galveston, Baghdad had asked the US marshals to monitor the offloading of
the crude, and its storage at Iraqs expense. However, the warrant filed with the
complaint did not seek the detention of the tanker, which is too big to berth
alongside, requiring offshore lightering.

According to Baghdads complaint, a contract for the lightering was already in place;
the tanker had already been authorised to proceed with offloading after an onboard
inspection by the US Coast Guard.

48 hours ago, in the first of a rapid series of confusing events, the Judge then
suddenly decided that - as the tanker was parked in international waters - the order
that she had signed could not in fact be executed.

Judge Nancy Johnson said "Seems to me this is not a matter for the U.S. courts to
tell the government -- the governments -- of Iraq who owns what. This just seems
way outside our jurisdiction.

The same day that the Judge was getting in a tangle, the KRG Minister of Natural
Resources Ashti Hawrami said The KRGs lawyers sent a letter to a court in Texas
to explain the misrepresentations of the Iraqi federal government. The Iraqi federal
government has petitioned a Texas court for an order to seize crude oil legally
produced, exported, and sold by the KRG in accordance with the Iraqi constitution
and law. The letter indicates the possibility of massive counterclaims against the
federal government.

As a matter of record, the wonderfully titled legal firm Wilmer Cutler Pickering Hale
and Dorr LLP, of 49 Park Lane, London, W1K 1PS sent a letter to the Hon. Gary
Miller, United States District Judge (etc) on 29 Jul 14.

The letter was 184 (yes, 184) pages long, and contained a mass of complex detail
on the hydrocarbons law and the Iraqi Constitution and intra-capital letter
exchanges.

Stand offs and Hands off

We seem therefore to be seeing a particularly important Middle Eastern version of a
Mexican standoff off the south coast of the US:

At stake for Irbil is the ability of Kurdistan to pay its bills and people and
achieve a major step towards economic independence;
At stake for Baghdad is the potentially terminal fracture of the fragile federal
Iraqi construct;
At stake for Washington is the credibility and clarity of its position on Kurdish
oil, and its reputation with the KRG as a fair-minded international partner.
While this is all going on, there are still a number of tankers carrying Kurdish crude
oil transiting the high seas.

The United Emblem has part unloaded its cargo in the South China Sea, although a
buyer has not been identified; it left Ceyhan last month with a cargo of some 1M
barrels of Kurdish crude.

According to Reuters, a senior source at Marine Management Services said the
ship-to-ship transfer involving the South China Sea cargo was sound.

Kostas Giorgopoulos was quoted by Reuters saying that The United Emblem is
"fixed to a legitimate charterer and performing legitimate operations" and "the ship is
still in international waters". Its destination remains unknown, along with the buyer.

We know from Reuters that US chemicals firm LyondellBasell had bought two
previous cargoes of Kurdish crude delivered to the US in May - without apparently
any legal hurdles.

The US denies banning Kurdish oil sales

Meanwhile, the US, seemingly bruised at Irbils rapid legal counterattack, has spent
the last 24 hours denying that they are banning oil sales from Kurdistan.

Yesterday, Deputy Spokesperson for the US State Department, Marie Harf, said
There is no US ban on the transfer or sale of oil originated from any part of Iraq.

And, in a somewhat interesting comment, she also said Our policy on this issue has
been clear. Iraqs energy resources belong to all of the Iraqi people. These questions
should be resolved in a manner consistent with the Iraqi constitution.

Not wishing to be left out, Deputy Assistant Secretary for Near Eastern Affairs for
Iraq and Iran, Brett McGurk clarified on Twitter Washingtons stance regarding the
Kurdish oil tanker. He tweeted There is no U.S. ban on the transfer or sale of oil
originating from any part of Iraq. Suggestions to the contrary are false.

He also stressed that the Washingtons policy on the underlying issue has been clear
and consistent; tweeting Iraqs energy resources belong to all of the Iraqi people,
which looks remarkably like what Marie Harf said.

Similarly, McGurk urged all sides to solve their differences based on the Iraqi
Constitution, saying The situation demonstrates why it is incumbent on Baghdad
and Erbil to find a negotiated resolution. As in many cases involving legal disputes,
however, the U.S. recommends that parties make their own decision with advice of

counsel. These questions should be resolved in a manner consistent with the Iraqi
constitution.

The whole point of the KRG letter to the US Judge was that Irbils actions are
consistent with their interpretation of the Iraqi Constitution.

But in yet another twist in the tale, only this morning the Kurds only US customer
LyondellBasell said that after receiving previous shipments it was halting all
purchases of what it called disputed Iraqi crude.

The company said in a statement "We have cancelled further purchases and will not
accept delivery of any of the affected crude until the matter is appropriately
resolved.

The Indefinite Articles

Baghdads position that they alone have the authority to sell oil and receive revenue
is not born out by scrutiny of the appropriate articles of the constitution. These are as
follows:

Article 111: Oil and gas are owned by all the people of Iraq in all the regions and
governorates.

Article 112: First: The federal government, with the producing governorates and
regional governments, shall undertake the management of oil and gas extracted
from present fields, provided that it distributes its revenues in a fair manner in
proportion to the population distribution in all parts of the country, specifying an
allotment for a specified period for the damaged regions which were unjustly
deprived of them by the former regime, and the regions that were damaged
afterwards in a way that ensures balanced development in different areas of the
country, and this shall be regulated by a law.

Second: The federal government, with the producing regional and governorate
governments, shall together formulate the necessary strategic policies to develop the
oil and gas wealth in a way that achieves the highest benefit to the Iraqi people using
the most advanced techniques of the market principles and encouraging investment.

Professor James R Crawford, Whewell Professor of International Law, offered the
following legal opinion of the two articles; this was included in the packet of letters
sent to the US Judge:

Article 112 of the Constitution of Iraq gives only a qualified right to the Federal
Government to "undertake the management of oil and gas extracted from present
fields". This right is to be exercised "with the producing governorates and regional
governments", and is subject to a condition of fair distribution of revenue on a basis
regulated by law. As to non-producing and future fields, there is under Article 112,
Second, no federal right to manage, although regional management of such fields
has to respect strategic policies to be formulated by the federal government "with"
the KRG.

The Kurdistan Region Oil and Gas Law is consistent with the Constitution of Iraq and
is effective to govern the development of oil and gas in the Kurdistan Region. In the
continuing absence of agreement pursuant to Article 112, Second, on the ''necessary
strategic policies", the KRG is entitled to manage its oil and gas resources, and
should do so openly in a manner which gives effect to the principles set out in that
Article.

Existing contracts entered into by the KRG for oil and gas exploration and
exploitation since 1992 are valid unless they conflict with the Constitution. Pending
agreement between the KRG and the federal government on strategic policies, the
authority of the KRG to authorise the conclusion and implementation of new
contracts is unqualified.

So What?

If the US administration is serious that There is no U.S. ban on the transfer or sale
of oil originating from any part of Iraq. Suggestions to the contrary are false, this
leaves the door open for the Kurds to sell their oil to US clients and international
buyers.

This will not only relieve the acute economic pain that the Kurds are currently
experiencing, but will be a huge step forward for the international oil companies who
are still waiting to be paid, and who are also waiting to turn the volume up on their
production and sale of oil.

Finally, it will mean that the grip that Baghdad has around Irbils throat will be
released, and Kurdistan will become a viable independent economy. Baghdad will
view this with horror, and thus we can expect Baghdad to be actively lobbying
Washington as we speak.

However, the proof of the pudding is in the eating. It remains to be seen if the rapid
series of denials by the US administration that they are banning sales of oil from any
part of Iraq will have the effect the Kurds want desperately to see the sale of their
crude oil unimpeded by objections from Baghdad.

Mars Omega LLP

When "common sense"
really amounts to
nonsense

Written by David Blackmon from FTI Consulting, Inc.
Taxpayers for Common Sense (TCS), one of the myriad agenda-based think tanks
in our nations capital, released a decidedly un-common-sensical new study on July
31 titled Effective Tax Rates of Oil & Gas Companies: Cashing in on Special
Treatment.

The study is 41 pages long, and purports to somehow be an authoritative analysis of
how oil and gas companies avoid paying taxes through various tax treatments, and I
encourage anyone interested to read it. But what it basically boils down to is an
argument that essentially says golly, if nasty old big oil didnt take advantage of the
tax code, theyd pay a higher effective tax rate. Which is true, as far as it goes.

But nowhere in the report does it also note that if, say, Microsoft, or Tesla, or AT&T,
or General Electric, or basically every other corporation that does business in the
United States of America didnt take advantage of the tax code, they would all pay a
much higher effective tax rate as well. Nor do the authors bother to note that if they
themselves didnt take advantage of deductions for mortgage interest, state and local
taxes and capital losses on their own personal income tax returns, they would also
pay a much higher effective tax rate.

See how that works?

As we pointed out in this piece last January, the oil and gas industry receives the
same kinds of tax treatments that every other manufacturing or extractive industry
receives in the federal tax code. There is nothing uncommon or out of the
mainstream of tax treatments about any of the provisions that have been repeatedly
proposed for repeal by the Obama Administration. Any person who really
understands how the tax code works would understand that reality, but TCS
obviously relies on the belief that most news reporters and editors are not among
such people.

And they would be right, as various news outlets have picked up on the study and
run misleading articles about it. U.S. News and World Report even gave space for an
opinion piece by TCS President Ryan Alexander. But our favorite thus far was this
piece at Salon.com that ran under the absurdly written headline, Big Oil Companies
Pay An Absurdly Low Tax Rate.

Naturally, Salon zeroes in on perhaps the single most misleading and inaccurate part

of the entire TCS study:

Oil and gas companies can defer tax payments for a variety of reasons, some
specific to the industry. If an independent oil and gas company constructs an asset
like an oil rig, for example, it can claim a tax deduction for all of its intangible drilling
costs (IDC), which include the costs of designing and fabricating drilling platforms.
This allows the company to immediately deduct all of these costs from its taxable
income. Normally, a taxpayer who constructs an asset would have to wait for the
asset to generate income and expense these costs over time, spreading its tax
deductions over 5, 10, or 20 years, depending on the useful life of the asset.
Deducting the entire amount immediately allows the company to defer or delay
payment of a portion of the taxes it accrued that year

[The principal benefit] is the ability to defer more and more of their federal income
taxes, year after year Over time, the total amount an oil and gas company owes
the federal government in deferred taxes can become significant. ExxonMobil
reported total deferred tax liabilities of $54.5 billion in 2013. It pays no interest to the
federal government on the amount it owes, even if it takes 20 years to pay it back.

First of all, TCS attempts to equate the building of an oil rig with the designing and
fabricating of drilling platforms, which are two completely different pieces of
equipment that are almost always constructed by completely different companies. It
also infers that these activities are typically engaged in by what TCS refers to as
independent oil and gas companies, by which one can suppose the authors might
mean independent producers of oil and gas. Salon then attempts to equate the
activity described in the first paragraph with tax deferalls allegedly taken by
ExxonMobil in the second paragraph. But ExxonMobil is an integrated company, not
an independent producer, and quite often is subjected to tax treatments that are
vastly different than those that apply to independent producers. Anyone familiar with
the oil and gas industry and the tax code would have known that.

As well, anyone who knows how the industry actually works would know that
independent producers seldom construct their own oil rigs by which one must
assume the authors are referring to drilling rigs, and that, in any event, the
construction of oil rigs is treated as a tangible capital cost in the tax code, and is not
allowed to be classified as an Intangible Drilling Cost (IDC), as the folks at TCS
clearly want their readers to believe.

As for the construction of drilling platforms an entirely separate piece of
equipment from an oil rig about 50 years of federal case law has led to a series of
court and IRS rulings that allow some of the costs to be treated as IDCs in certain
fact situations, and some of the costs to be classified as capital costs that must be
recovered over multiple years. And, by the way, the underpinning rationale for those
court and IRS rulings is the very same rationale that the courts and the IRS apply to
every other industry in the United States of America when determining whether
specific costs can be deducted in the year in which they are incurred, or must be
amortized and recovered over time.

This fundamental and enduring basic concept of federal tax law was apparently
beyond the ability of the folks at Taxpayers for Common Sense to grasp when

constructing the thinly-disguised hit piece they refer to as a study.

At the end of the day, this TCS study doesnt really seem to make a lot of sense.
Those who know how the oil and gas industry, and the tax treatments that apply to it,
actually work might even call it nonsense.

FTI Consulting, Inc.

North Sea Oil and
Scottish
Independence: where
does the truth lie?

Written by Euan Mearns from Energy Matters
How much oil and gas is left in the North Sea? 16 billion barrels oil equivalent
(boe) according to Sir Ian Wood or 24 billion boe according to Oil and Gas
UK? The correct answer for official proved+probable reserves is between 8
and 9 billion boe, a figure that both DECC and Oil and Gas UK agree on. With
over 9 different classes of reserves, this debate is sterile and this is not the
correct question to ask.
How wealthy will oil make Scotland? In 2013, the direct tax take from oil and
gas production for the whole of the UK was 4.67 billion and falling. This
compares with annual spending of the Scottish government (plus UK
spending on Scotland) running at 65.2 billion. Hence, direct taxation of oil
and gas production may account for less than 7% of the Scottish budget.
What we should be asking is where the other 93% is going to come from?

On 18th September this year people resident in Scotland be they Scottish, English,
Irish or Polish will vote on Scotlands continued membership of The United Kingdom.
The debate is heating up. Oil magnate Sir Ian Wood suggests that remaining oil and
gas reserves are about 16 billion barrels oil equivalent (boe). While industry
representative Oil and Gas UK suggest a figure of 24 billion boe, a figure preferred
by the pro-independnece lobby. As discussed below, both of these numbers as they
stand alone are totally meaningless.

Voters are clearly confused and are pleading for real data upon which to base this
most crucial of decisions. In this post I attempt to bring some reality to the debate
about North Sea oil and gas reserves, production and finance.

Reserves Figures are a Sterile Debate

The Society of Petroleum Engineers provides a framework for the classification of
reserves based on class and certainty [1]. There are three classes and three
certainty levels giving at least 9 different classifications of reserves (Figure 1). And
so, when a number of 24 billion boe is reported it is essential to qualify this with the
classification terms. Are these 2P reserves? i.e. oil and gas known to exist with a
high degree of certainty. Or are they 3P reserves + resources, i.e. oil and gas
optimistically hoped to exist, but yet to be discovered or a means of production
economically worked out.

Figure 1 Classification of reserves according to The Society of Petroleum Engineers.
The industry standard is normally to report 1P or 2P reserves (the middle of the
green band).


Figure 2 UK North Sea reserves estimates from various sources [2]. The 2P figures
from the Government (DECC) and Oil and Gas UK are actually closely aligned at
between 9 and 11 billon boe oil + gas (updated to 8 to 9 billion boe). See note at the
end of this section). With over 42 billion boe already produced it seems likely that
80% of UK oil and gas is already gone.

A year ago I conducted a review of reserves from different sources including my own
back of the envelope calculation using industry standard methodology [2] (Figure 2).
There is a degree of agreement where the proved oil and gas reserves category lies
somewhere between 4 and 5 billion boe. Proved + Probable (2P) reserves stand at
around 8 billion boe according to DECC [3] and about 9 billion boe according to Oil
and Gas UK [4] (see note at the end of this section). How these figures become
inflated to 16 and 24 billion is pure speculation.

Oil and Gas UK qualify their numbers with the need to spend 1 trillion to get their
high end estimates out of the ground (Figure 3). Considering that current investment
levels are running at around 20 billion per year it will take 50 years to reach that
target. Most of the existing infrastructure will have fallen into the North Sea long
before. Production growth is now negatively correlated with investment (Figure 4)
and one needs to ask the question how likely it is that the industry will sink another
1 trillion into this ageing, mature province? It is of course Oil and Gas UKs
business to talk the industry up.

Figure 3 Excerpt for Oil and
Gas UKs 2013 financial report
revealing how they get from
7.4 to 24 billion boe [4].


Figure 4 Despite rising and record levels of investment in the North Sea, oil and gas
production has continued to decline [5].

At the current mature stage of North Sea development, oil price is vitally important.
With Brent approaching $100 / barrel, companies in Aberdeen are preparing for
recession. There are of course bright spots like Clair, Mariner and Laggan Tormore.
But there are many black spots where companies can no longer afford to maintain
rusting platforms producing a mere dribble of oil. The UK industry currently needs
sharply higher oil prices to prosper.

[Note added 17:00, 25th August. I received a few emails from DECC providing more
up to date figures than the ones I was using that were complied last December:

Last year we said P+P reserves were 8.9 billion boe. Which I guess explains where
your 9 billion boe comes from. Oil & Gas UK were at 9.9 billion boe so I dont see
why you say between 9 and 11 billion boe. It would be more accurate to report
DECCs current estimate of 8 billion boe and Oil & Gas UKs of 10 billion boe.

Oil & Gas UK now say 9.4 billion boe (see attached) so the range should be 8 to 9
billion boe rather than 9 to 11 billion boe.

The numbers in the post were therefore revised accordingly.]

The Harsh Reality of Production Decline

Combined UK oil and gas production peaked in 1999 (Figure 5). We have now
experienced 14 years of relentless decline. This is not speculation but a fact.
Production today is 32.4% of the 1999 peak value. Decline is a feature brought about
by the depletion of reserves and pressure. At first a field will produce dry oil. But with
the passage of time increasing amounts of water are produced with the oil. The
industry fights decline 24/7. But it is rather like swimming upstream in a river against
a strong current. You may want to get upstream but the current relentlessly wants to
drag you down.

There are signs that declines are being stabilised for the time being. This has been
brought about by record levels of investment that will not be maintained at current
prices [5]. Some large new fields due to come on stream in the near future may
arrest or temporarily reverse the long-term decline picture. But all of the fields
represented in Figure 5 will still be there pulling production down.

Figure 5 The history of UK oil and gas production according to the 2014 BP
statistical review of world energy.

With over 42 billion boe already produced from the North Sea [4], it seems likely that
about 80% of the producible oil and gas has already gone. The industry will of

course continue for many decades, but on current data it will be at a much lower
level than in the past. However, one can never discount a new oil and gas province
being discovered in the waters to the west.

The Financial Reality

Direct taxation of the UK oil and gas industry since 1968 is shown in Figure 6 [6].
Direct taxation is in the form of a Petroleum Revenue Tax and Corporation tax that
oil and gas operators pay at a higher rate than other companies.

In 2013 the total UK direct tax take from Oil and Gas was 4.67 billion [6]. In 2012/13
total UK and Scottish Government expenditure on Scotland was 65.2 billion [7].
9.1% of the UK total even though we have only 8.3% of the population. Hence direct
tax revenues from oil and gas will amount to less than 7% of the total Scottish
budget (the North Sea oil tax figure is for the whole of the UK). Important to be sure,
but not nearly as important as the 93% (60.6 billion) that will have to be found from
other sources.

Figure 6 Data for total direct taxation of the UK oil and gas industry [6]. The roller
coaster ride in tax income comes down to a combination of production rise and fall,
oil and gas price rise and fall, changes in operating costs and changes to the
taxation regime. The current environment is one where oil prices have more or less

traded side ways since 2008, production has continued to decline and operating
costs have gone through the roof. The industry in Aberdeen is preparing for a new
cyclical recession. Contractors are being laid off or their rates cut and the operating
companies are preparing to lay off staff.

Whilst important, the direct tax take from North Sea oil is by far NOT the most
important aspect of the industry to the Scottish economy. The benefits to the
economy comes from the economic activity that the oil industry creates. It creates
jobs directly in the operating and service companies and in the supply chains. In
2012 this expenditure amounted to 22 billion spent on goods and services, not all of
it spent in Scotland. A large amount is spent on salaries to people living in Scotland
who then spend this money in local shops, pubs and restaurants. It is true that the
tax revenue generated from this activity is shared with the whole of the UK. But it is
the economic activity itself that is most important, and this already exists in a
Scotland that is part of the UK.

Of similar importance is the fact that Scotland is now a hub for hemispheric oil and
gas activity. US companies, based in Scotland, may employ staff here servicing the
oil industry in Algeria, Azerbaijan or Nigeria. These companies want stability and
certainty to continue their business in an increasingly uncertain world. Similarly UK
(Scottish) companies that grew out of the North Sea oil boom like The Wood Group
serve the global industry providing jobs and prosperity to Scotland. These
companies too want fiscal and currency certainty looking forward. The focus on
ethereal reserves is a mistake, the focus on direct tax income is a mistake. The
focus should be on the continued existence of a multi-billion industry that provides
jobs and prosperity for many and a single minded focus on doing nothing that may
jeopardise the present or the future.

References

[1] SPE: Guidelines for Application of the Petroleum Resources Management
System
[2] Energy Matters: UK oil and gas reserves
[3] DECC: Oil and gas: field data
[4] Oil and Gas UK: Economic report 2013
[5] Energy Matters: UK North Sea Oil Production Decline
[6] HM Revenue and Customs: Statistics of Government revenues from UK oil and
gas production
[7] The Scottish Government: Government Expenditure & Revenue Scotland 2012-
13

Energy Matters

Making sense of the US
oil story

Written by Gail Tverberg from Our Finite World
We frequently see stories telling us how well the United States is doing at oil
extraction. The fact that there are stories in the press about the US wanting to export
crude oil adds to the hype. How much of these stories are really true? If we believe
the stories, the US is now the largest producer of oil liquids in the world. In fact, it
has been the largest producer since the fourth quarter of 2012.

Figure 1. US Total Liquids production, including crude and condensate, natural gas
plant liquids, other liquids, and refinery expansion.

Oil Extenders

One of the issues is that a few years ago, the US created a new oil-related grouping,
combining valuable products with much less valuable (lower energy content, less
dense) products. Using this new grouping, the US was able to show much improved
growth in total oil supply. The US EIA now calls the grouping Total Oil Supply. I
refer to it as Total Liquids, a name I find more descriptive. Besides crude and
condensate, the mixture includes other liquids, natural gas plant liquids, and
refinery expansion.

Crude and condensate is the original grouping. Often, it is just referred to as crude
oil.

Other liquids is primarily ethanol from corn. If we produced coal-to-liquids, it would
be in this category as well.

Natural gas plant liquids (NGPL) are the liquids that condense out of natural gas
when they are chilled and compressed in the natural gas processing plant.

Refinery expansion occurs when a refinery breaks long chain hydrocarbons into
shorter ones. The resulting products take up more volume, but dont really have
more energy content. In some ways, the process is like making whipped cream out
of whipping creammore volume, but not really more product. The new products
tend to be more valuablesay, diesel and lubricating oil made from something close
to asphalt.

The process of breaking (cracking) long hydrocarbon chains is a valuable service to
those producing heavy oils, because it makes valuable products from crude that
otherwise would not have been useful for most purposes. The cracking process uses
natural gas. Because natural gas in the US is inexpensive relative to its price in most
other countries, the US can perform this process more cheaply than other countries.
Because of this, it makes financial sense for the US to import heavy crude oil and
process it in this way, whether or not US citizens can afford to buy the finished
products. (Cracking is not useful on very light oil, such as Bakken oil, since it has
primarily short chains to begin with.) If US citizens cant afford the finished products,
they are exported to others.

Whether or not the US should be credited with this expansion of volume is somewhat
iffy, since the process doesnt add energy content. Quite a bit of the oil processed
in this way uses imported oil, such as oil from the Canadian oil sands.

If we look at the base figure reported by the US Energy Administration, that is,
Crude and Condensate(Figure 2), the US does not come out as well in original
comparison (Figure 1).

The United States makes much greater use of extenders than do Russia and Saudi
Arabia. If we calculate the ratio of extenders to the base (crude and condensate), the
ratios are as follows:

Figure 3. Extenders as a percentage of crude oil production, based on EIA data.

Both Russia and Saudi Arabia have much lower ratios of extenders. For both of
these countries, the extenders are Natural Gas Plant Liquids.

Natural Gas Plant Liquids (NGPL), have varied in price. For a while, the price was up
with the price of crude, but as supply increased, the US price dropped during 2011
(Figure 4).

Figure 4. Price Comparison per Million Btu for Oil (West Texas Intermediate),
Natural gas plant liquids, and natural gas, based on EIA data.

This drop in NGPL price occurred because the US market for at least some
components of this grouping became saturated. With too much supply for demand,
prices dropped. Excess ethane, for example, could be sold to be burned as natural
gas, putting a floor under its price. As a result, recent prices seem to be influenced
by changes in natural gas prices.

With the drop in NGPL prices, we hear more talk about the need for exports. We
dont really have use for all of the low value products that are being produced, other
than to burn them as part of natural gas. Perhaps someone else does. If someone
else does, it might get the price back up.

What is the Real US Trend in Production/ Consumption?

The US EIA makes fuel comparisons based on Btu energy content. This approach
makes it easy to see how much of our fuel is US produced, and how much is
imported (Figure 5).

Figure 5. Comparison of US production and consumption of oil plus NGPLs, based
on EIA data.

Production is indeed rising, but it is still far below consumptionabout 55% of
consumption in 2013. Many articles make this situation confusing.

The emphasis in most news reports is the drop in importsthat is the difference
between the blue line and the red line in Figure 5. If we look at the chart, though, we
see that a big reason for the drop in imports is a drop in consumption, with the big
step down coming in 2007 and 2008. Oil use is associated with jobs. It takes oil to
make and transport goods. Also, workers with good jobs can afford cars and the oil
to operate their cars. If they remain students forever, they cant afford cars.

A person can better see the drop in consumption by looking at consumption on a per
capita basis.


Figure 6. US per capita oil and Natural Gas Plant Liquids production and
consumption, based on EIA data.

If prices dont fall, consumers dont feel the effect of more production. What they do
feel the effect of is falling consumption-the top line. Young people especially have
been finding it hard to get good paying jobs. With all of their student loans, it is hard
to be able to afford to get married and buy a house. This holds down demand for
new homes, and all of the things that go into new homes.

If we look at total per capita energy production and consumption in the US, we see
even more of this trend. While production per capita is rising, an even bigger issue is
falling consumption.

Figure 7. Total per capita energy production and consumption for the US, based on
EIA data.

US per capita energy consumption has been dropping since 2000. 2000 is the year
of peak US employment, as a percentage of the total population.

Figure 8. US Number Employed / Population, where US Number Employed is Total
Non_Farm Workers from Current Employment Statistics of the Bureau of Labor
Statistics and Population is US Resident Population from the US Census. 2012 is
partial year estimate. (Sorry, not updated.)

With a smaller percentage of the US population employed (and lagging salaries for
those employed), US consumers cannot afford to buy as large a quantity of energy
products. Rising US oil production is not really helping US consumers, because at its
high price, we cannot really afford it.

Rising oil production has not brought down oil price, making it more affordable. In
fact, the situation is the reversehigh prices are needed for todays oil production. It
is questionable whether todays prices are even high enough. Oil companies have to
keep adding debt, to keep extracting oil. The EIA recently wrote an article about the
situation called, As cash flow flattens, major energy companies increase debt, sell
assets. Steven Kopits shows this chart of cash flows for Independent Oil Companies
in a recent post.


Figure 9. Image by Steven Kopits showing Free Cash Flow of US independent oil
and gas producers, from Platts Guest Blog.

With negative cash flows, companies have to keep increasing their debt levels
something that eventually becomes impossible.

When those producing the oil see that US oil prices are at times not as high as world
oil price (Brent), they hope that selling their crude to world export markets, they will
be able to get higher prices for their crude. If they are successful, there will be less
crude available sold to US producers, perhaps raising the price of this crude sold in
this country as well. The net impact may be higher prices for US consumers, making
the US consumers even less able to afford the oil products.

Energy Growth is Needed for Economic Growth

There is a close tie between energy consumption and economic growth. Perhaps my
statement Energy growth is needed for economic growth, in the header is a little
too strong. Perhaps if energy consumption is flat, with the benefit of technological
progress and efficiency changes, there can still be economic growth. There is
definitely a connection, though. Energy of the right type is needed for every process
we can think ofgetting to work, shipping goods, operating our computers, heating
metals when they are refined.

The problem comes when what we are facing in shrinkage of energy consumption,
over and above what can be accommodated by technological progress and
efficiency. Figure 7 hints that this is already happening. Then we have danger of a
collapsing financial system, as the low energy consumption growth pushes the

economy toward contraction. The economy has been held together since 2008 with
quantitative easing and zero interest rates. The plan has been to allow consumers
more income to spend, by keeping interest rates artificially low. I heard an excellent
presentation on this subject recently called Global Financial System on Life Support
by Roger Boyd.

Conclusion

I wrote a post recently called The Absurdity of US Natural Gas Exports. The situation
with exports of crude oil is not quite as absurd. The issue is that current oil refineries
are not configured for the influx of very light oil. Many of them are busy cracking
long hydrocarbon chains, often using imported oil as their energy source. If US oil
producers have the option of selling their crude oil abroad, perhaps they can get a
higher price for it. If US oil producers can get higher prices for their oil, this may very
well filter through to higher oil prices for US consumers, and less oil consumption by
US consumers, but this is not the concern of oil companies.

A major concern with falling per-capita energy consumption it that the financial
system may soon reach limits where it is stretched beyond what it can stand. The
economy needs energy growth to grow, but the economy is not getting it.

Our Finite World

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OilVoice Magazine - September 2014

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Edition Thirty September 2014

Making sense of the US oil story

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