"The situation is real. And it is very grave."

Energy in the New Economy:
The Limits to Growth

Matthew Simmons is a hard-core business guy.  Harvard graduate, investment banker, merger and acquisitions specialist to the oil service industry.  He may be too optimistic.

The text of a speech given by
Matthew R. Simmons , President SIMMONS & COMPANY INTERNATIONAL
October 2, 2000
at the
Energy in the New Century
conference hosted by
The Energy Institute of the Americas
Oklahoma City, Oklahoma

In the short time allocated to our opening remarks, I will not even attempt to quantify any added views on the supply and demand for either North American natural gas or worldwide oil. The task is actually impossible to do with any degree of precision as medium-term demand for energy sources might be severely limited by no extra supply. Reliable short-term, medium and long-term supply numbers also cannot be calculated with any degree of precision without having access to data on the relentless decline rates that are occurring in almost every significant oil and gas field in the world. Sadly, this data does not even exist in any published form.

What I want to address today are the physical limits we face to increasing supply of either North American gas or worldwide oil. Limits at the wellhead, limits at the rig, limits to transportation, limits to virtually every moving piece of the system. At the end of the day, these physical limits, and the time, people and capital required to eliminate them, will determine the length and severity of the Energy Crisis that is now descending over the world.

For a decade, I have worried and warned about the prospects of facing another Oil Shock. I experienced the effects of the two oil shocks of 1973 and 1979. Both were ugly events. They also triggered the only major recessions I have ever personally known. I tried to warn various industry and public service groups that energy troubles were ahead unless a lot of changes were made, like drilling a lot more wells and expanding our pipelines and refineries. But nobody chose to hear my message, or heard it and said, “What a bullish view. If he is right, oil prices will rise.” And they ultimately did.

So a decade of warnings went unheeded and today we find ourselves in the early stages of a savage Energy Crisis. But it turns out to be far different crisis than what I originally worried about. I feared we would face an Oil Shock. I was wrong. We are now facing a true Energy Crisis as too many key parts of the world have run out of the ability to increase electricity demand, natural gas demand and petroleum demand. All three prime sources of energy converged into a limit against further growth almost simultaneously.

The situation is real. And it is very grave. If any of you read “The Perfect Storm” where a 100-year world-class storm materializes out of nowhere through the convergence of three freak weather systems, our Energy Crisis results from the same phenomenon. All three energy fronts are now colliding with each other.

Let me also be perfectly clear. The world has not run out of oil and North America has not run out of natural gas. Moreover, there are still lots of potential kilowatts to create. What we have run short of is any way to grow the supply of each of these energy sources. In the meantime, significant bottlenecks exist which will possibly make it hard to even keep the supply of all three energy sources flat.

There is a definite risk that each source could actually decline before any solutions to finally get supply growing again can be implemented. Let me begin putting some details into this bleak picture with a few commentaries on world wide oil supplies. There are only a handful of meaningful new supply projects now underway throughout any of the 40 key countries that keep the world oil supplies in tact. Do not look for a lot of growth in worldwide oil supply from new projects coming on stream. There are not enough projects for this to happen through at least 2005. The big supply question on the oil front is how much capacity is left behind OPEC”s wellhead valves, just waiting for a valve to open before coming on stream.

There is lots of speculation about OPEC’s excess capacity. But all guesses are simply guesses. No one really knows the answer and no one will know until it is clear that all the taps are finally on. The guesses still range from as high as 3 million barrels a day to as little as 500,000 barrels a day. But even these numbers often start with a difference of opinion on what the OPEC countries are now producing.

I might as well throw my guess into this vacuum. It would be impossible for the world to still have 3 million barrels a day capacity left. The people tossing out these numbers lack the knowledge of what too many key fields are now doing to make these guesses even credible. I worry that the real number is very near the bottom of this range and maybe even below 500,000 barrels per day. But, my guess is simply a guess.

North American natural gas has no excess capacity. It disappeared several years ago. What we do have is extremely aggressive decline rates in almost every key production basin making it harder each season to keep current production flat.

The electricity business has also run out of almost all existing generating capacity, whether this capacity is a coal-fired plant, a nuclear plant or a dam. The electricity business has already responded to this shortage. Orders for a massive number of natural gas-fired plants have already been placed. But these new gas plants require an unbelievable amount of natural gas. This immediate need for so much incremental supply is simply not there.

For all intents and purposes, we are now out of any meaningful energy cushions, not just in the U.S. but virtually throughout the world. This picture is grim enough. But it is merely the tip of the “limitation iceberg.” We have about 120 spare rigs of any type in the entire world which are currently idle. But, shift to any continent and you end up seeing 20 spare land rigs in Africa or 9 in Europe.

These are not big rig numbers for significant drilling arenas. 120 spare rigs are not many in the first place, but when you look at the quality of many of these rigs, you see many are at the bottom of the food chain and are in terrible shape. It is also questionable whether some of these rigs can even work or can get trained crews to run them.

When the world is finally out of rigs, as happened in late 1997 through the middle of 1998, until the oil price collapse drove drilling activity down again, we then face a long march to attempt to grow the rig count. For the next five years, the battle will be rig growth versus rig attrition. So, there is a chance that rig activity will stay flat for some time even though 25 to 30 rigs are added each year. This sounds like a small number but it represents my best guess at the manufacturing capacity to build new drilling rigs on a worldwide basis.

Drilling rig manufacturing capacity can be expanded. But I fear it will take a year or two of utter confusion to finally give the handful of rig manufacturers the courage to begin building new plants. After all, they were enforcing layoffs once more only 18 months ago.

If the lack of rigs were the energy industry’s only problem, it would be bad enough. But superimpose on this shortage a lack of spare refinery capacity in the United States and probably Europe. Then add to these woes a worldwide lack of any spare tanker capacity. The tanker shortage also makes any spare wellhead capacity in the Middle East irrelevant for any consumers who have to transport the oil over the waters.

We are also out of most pipeline capacity in too many key markets and we lack a reliable electricity transmission system in the U.S. even if we still had spare generating capacity.

Each of these limits are “hard iron and steel” related. When you are out, you are out until something new gets built. But, these limits might be the easy part of the picture. Recruiting new energy industry people is a problem of even graver magnitude.

We are barreling into an era, at least in the U.S., where we have to cap any further growth in demand for all forms of energy. It simply cannot happen. Hopefully we can find a way to keep the current energy use flat, but even this modest goal will not be easy.

What makes this energy outlook so sad is that it did not need to happen. Had the energy business or the government better understood how to properly analyze the right data, and appreciated some of the flaws in this data, so many of the terrible energy mistakes we made throughout the 1990’s might not have occurred.  But the mistakes were real and the Energy Crisis is also real. My worst fear today is that we accidentally make it worse. There is an old adage “When you suddenly find yourself in a hole, rule number one is to stop digging!”

Because so few key decision-makers understand we even have a critical problem on our hands, there is a great risk we postpone any real corrective steps while also imposing further damage.

I wish I had better news to deliver today. This will be a tough surprise for our financial markets that seem convinced that today’s seemingly high energy prices will soon go away. I fear the prices might go away, but not in a downward direction.

It is time for everyone to take off their rose-colored glasses or to casually dismiss views like mine as being overly bullish or overly bearish. We are about to get a real energy wake-up call. Sadly, the alarm went off too late. There is no reason to believe that these limits cannot ultimately be solved, but getting this done will consume most of the next decade.

Thank you for letting me address these extremely serious issues on this important forum.

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