We Don't Know Jack

Brian Hicks

Written By Brian Hicks

Posted December 21, 2006


Editor’s Note: For an updated chart on how far we now go for oil, click here…


Sometimes I feel sorry for journalists on the energy beat. Most of them are your basic college-educated, liberal arts generalists, with a flair for communication but not necessarily math or science.

Unfortunately, in a world waking up to the fearsome reality of peak oil, good numbers are hard to come by. This is especially true in the oil business, where “tight holing”—keeping information top secret—is a term as old as the business itself.

But there are some numbers that are available, and some of them are pretty reliable. And even a journalist has the math skills needed to work with those numbers—it’s basic arithmetic.

So when Chevron announced a “new” find in September of some three to 15 billion barrels of oil in the Gulf of Mexico, with a possible production rate of 300,000 to 500,000 barrels per day of light sweet crude, I looked for some good journalism about this exciting new discovery.

But I didn’t find it.

The Globe and Mail published an article called “Peak oil theorists don’t know Jack,” a short little puff piece that carefully skirted any facts and selectively quoted the press release, while suggesting that peak oil fears should be forgotten.

Business Week, in its similarly short bit of happy talk, opened with “You can tune out all the scare talk about Peak Oil for a while—probably a long while.”

BW also said that the field would “get into full-fledged production four or five years from now.” The glowing piece ended with a lovely quote from a director of CERA: “Peak Oil theory is garbage as far as we’re concerned.”

All of the coverage was long on propaganda and very short on facts. So I went off in search of facts, such as are available, anyway. And then I had a little more sympathy for the journalists out there, as I started to plow through lovely paragraphs like this one:

The total estimated ultimate recovery for the onshore Wilcox is 24 Tcf gas or 4 BBoe. Not until the drilling of the BAHA 2 well in March 2001 was the linked depositional system of the Wilcox from shelf fluvial deltaics to basin deepwater turbidites, a distance greater than 250 mi (403 km), tested by the drill bit.

Whoa. Thick stuff. But I pressed on. Because I want the facts, and you want the facts, and the good propagandists like the guys over at CERA have a vested interest in keeping them away from us. It’s a dirty job, but somebody’s gotta do it.

Just the Facts, Jack

For your consideration then, here are the facts.

The Jack #2 flow test well, the cause of all this excitement, was actually drilled two years ago in “Walker Ridge Block 758” of an area called the Lower Tertiary Wilcox, in the deepwater Gulf of Mexico.

MapChevron spent those years testing and evaluating it, in part because the reservoir where it is located is of a peculiar sort and raises a lot of questions, particularly about its ability to sustain a good strong flow of oil.

More questions resulted from mere fact that Jack #2 was an engineering marvel, an amazing technical achievement by the oil business in its absolute prime. Just drilling Jack #2 required going beyond the limits of current technology, breaking more than a half dozen world records for drilling tests.

For starters, it was drilled in 7,000 feet of water and extended more than 22,000 feet deeper into the seafloor. Nothing of this kind had ever been done before, leading even veteran drillers like Charlie Brister to say “My hardhat is off to them.”

To happy-talk peddlers like Business Week, that’s enough to declare a new era of oil bonanzas ahead. But not so fast.

The partners in the project (Chevron, Devon and Statoil) haven’t even decided yet whether the Jack field will be developed. They are going to drill another appraisal well in 2007, and maybe make a decision in 2007 or 2008, with initial production to begin around 2013, if all goes well. In fact, it was extraordinary to even drill this flow test well in deep water, due to its sheer cost: $30 million or more.

That’s a lot of money for a test. Why are they proceeding so cautiously?

Deep Pockets Only Need Apply

Most experts say that ultra-deepwater wells break even around $40$45/barrel, and lately, crude is holding up pretty well in the low $60s. The price is right, the oil is there, and the world is thirsty, so why wouldn’t the Jack field have the green light already?

For one, ultra-deepwater projects are mind-bogglingly expensive. If they started renting a rig next year, they’d be paying $460,000 per day for it, as compared to the $190,000 per day they’re paying this year.

Read that again, dear reader. The rig alone would cost them $460,000 per day!

That’s about $170 million a year, just to rent the rig. (And that profit outlook is why Transocean (RIG) is one of my favorite drilling picks.)

Now, one thing I have noticed about cost projections for big energy projects is that they’re almost always severely short of reality. Back in July, an oil sands company reported that its actual costs were going to be 50% higher than it projected just a few years back. And they got whacked for it on the Street, to the tune of about 20% in a few days. How did that happen?

Because they didn’t allow for the simple fact that prices for raw materials and, ironically, fuel, are increasing much more quickly than they have in the past. Steel, copper, oil, cement, rubber . . . they’re all going through the roof, doubling or better every year. And the costs of drilling rigs and skilled labor are skyrocketing, because there simply aren’t enough of those either.

The oil industry is actually in deep trouble. Its workforce is aging, and the ranks of younger workers have gone unfilled for decades. Almost everybody is over 50. Many schools stopped graduating geologists in the mid 80s, as oil plummeted, due to a lack of student interest. A lot of seasoned hands are staying on well into their retirement years, because there’s nobody else to do the work. At the first ASPO Conference, I sat next to a gentleman at the age of 90 who was still on contract with the Department of Energy . . . they just couldn’t afford to let him stop working.

Chevron and its partners are, no doubt, well aware of these trends. They deal with them every day. But I wouldn’t put it past them to underestimate the costs today in order to keep the investors showing, and the oil flowing, tomorrow.

In terms of total capital expenditure, comparable deepwater Gulf of Mexico projects by Chevron cost in the range of $28,000 to $33,000 per barrel-per-day production rate. So even if we accept the low end estimate of 300,000 barrels per day out of Jack #2, we’re talking $8.4 to $9.9 billion in costs.

Frankly, I think they’ll be lucky to produce the Jack field for $9.9 billion. Given the exponential rate increases charged by rig owners in the last few years, it’s impossible to say what they will be charging seven years from now when Jack might start producing. But I think it’s safe to expect that it will be much, much more than even the sky-high rates predicted for next year.

Technical Challenges

Then there are the many technical challenges yet to be solved. Let’s take look at some of them.

One problem is that the oil is just plain hard to get at. Aside from being at a very great depth, the Lower Tertiary Wilcox formations are located under a complex canopy of “allochthonous salts,” which are very expensive and difficult to drill through. One geologist notes that “it is cheaper to send space probes to Mars or Saturn than to drill beneath the deep salt.”

Another is that the quality of the fields has yet to be proven. Most of the fields in this formation are neither regular nor fully formed. The quality of the oil is highly variable, with some areas producing light sweet and others producing sour with more than 4% sulfur content.

Maybe the whole reservoir where Jack #2 was drilled will produce the light sweet crude that they got in the test . . . and maybe not. Some reservoirs haven’t completed the eons-long process of breaking down the organic matter from which oil is formed into the most desirable, lighter fractions.

The most crucial factor, and apparently the primary reason why the Jack #2 test was done, is the flow rate. There may be a bazillion barrels under there, but if you can only harvest it by the drop, it’s not worth much to you. The flow rate is largely the result of the type of source rocks in the formation: how porous is the sponge?

The Lower Tertiary Wilcox is mainly made up of a type of low-permeability, very fine-grained turbidite sandstone, which is less than optimal for sustaining a good flow rate. The Jack #2 test indicated a flow rate of 6,000 barrels per day, but this is only one data point—which is why renowned expert Matthew Simmons scoffed when he heard about the results. One data point does not a trend make. There is no guarantee and no proof that that flow rate can be sustained.

A final significant challenge exists in just getting the oil to market once it’s produced. There are no pipelines that far out in the Gulf. Floating production, storage and offloading vessels have been considered, but they don’t solve yet another problem that faces Jack: how to deal with the associated natural gas.

In the past, natural gas (which is a common component of what gets pumped out of an oil field) has been “flared”—just burned off on site. But for obvious environmental reasons (not to mention the sheer waste of very valuable hydrocarbons), the Mineral Management Service, which leases the deepwater blocks, frowns upon flaring. That leaves reinjecting the gas back into the field, which is a good thing for maintaining reservoir pressure, but also significantly increases the costs.

Where’s the Beef?

Finally, and perhaps most importantly, is the question of how much oil is really there to be produced. When I read the three to 15 billion barrel estimate in the press release, my first thought was, “Whoa! Bit of a spread there, isn’t there, guys? What’s up?” And I couldn’t understand why none of the commentators I read even seemed to lift an eyebrow at it.

Perhaps it’s because the answer isn’t the one they wanted. The likely quantity of recoverable oil is closer to 3 billion. To produce 15 billion, you’d need 276 square miles or 31 Gulf of Mexico outer continental shelf blocks. Jack only covers 18 square miles in two blocks.

Digging further into the facts of the region’s geology, the test wells that have been drilled and the probable output of those wells, it would appear that not only is the entire region not likely to produce anywhere near 15 billion barrels, but also that the Jack discovery itself is unlikely to approach the stated 300,000 to 500,000 barrels per day.

I was starting to feel like the lady in the old hamburger commercial, opening the two buns and exclaiming “Where’s the beef?”

Realistic Projections

Given the many questions that remain to be answered and the technical challenges that have yet to be solved, it’s no wonder that Chevron and its partners are taking a cautious approach to Jack. Investors—even confident, record-breaking, highly experienced investors like Chevron—don’t step up with that kind of money until they’re very, very sure about it.

So every question about the reservoir’s quality, every delay inherent in trying to do what has never been done before and every bad weather event will make that money drag its feet just a little more.

Which brings us to the question of timing.

By the time Jack is producing at full steam—let’s go ahead and take the 2013 estimate, even though we think that’s optimistic, given the many technical challenges—we will probably be three to five years past the peak in global production. Not only will Jack’s production not be enough to let the U.S. declare energy independence, it will be lucky just to compensate for the decline rate (about 5%) in our aging domestic fields.

But don’t take my word for it. Here’s what Shell’s executive vice president of exploration and production in the Americas said about the Gulf of Mexico in response to the Jack announcement:

“It’s going to continue to be very important from a total output standpoint, whether there is real growth potential, meaning to grow above volumes we have today, or if it is just replacement volumes.”

Wow. There you have it.

The U.S. supply picture gets worse when you realize that we still haven’t taken into account the very serious problem of the production decline from Mexico’s super-giant Cantarell field, from which we import a large amount of our oil.

Once thought to have a relatively steep decline rate of 7%, it now appears to be going into a much steeper decline curve than anyone expected, possibly as high as 14% per yearlikely due to mismanagement of its production rates. Nor have we taken into account the increasing global competition for oil, particularly from China and India. From both factors, the U.S. stands to lose a significant portion of its current imports in the coming years.

The Bottom Line

Chevron’s achievement is truly awesome and deserving of a standing ovation. I have no reservations about that. Even if the Globe and Mail’s “elephant” field turns out to be closer to a mouse, it’s still a stunning technical milestone.

If deepwater fields like Jack can somehow be harvested successfully and the oil brought to market, it means that the whole world has just a bit more time to make the transition away from hydrocarbons. And that’s time we desperately need.

But let’s be realistic about Jack. The increased production that we may hope for from the entire Gulf of Mexico, including Jack, will, at best, offset our domestic production declines over the next decades.

And maybe that’s a worthwhile motivation.

Here are the facts: Neither Chevron nor its partners have released any details about the quality of the oil or the characteristics of the Jack #2 reservoir. We don’t know what the sulfur content is, and we don’t know how much of it is gas. We can, however, say with complete confidence that we don’t know Jack.

Business Week’s claim that exotic offshore production from fields like Jack will “tip the balance of supply and demand in the long term” is a reprehensible speculation, just another verse in the swan song about cheap oil and endless economic expansion. A ruler to the knuckles for such shoddy, Pollyannaish journalism! The math isn’t that hard, and neither are the concepts. If you want the sweet treacle of promise, by all means belly up to Business Week and CERA.

But if you want the truth, come to us. We’ll give it to you straight—like a shot of whiskybecause there’s no call here for champagne. Peak oil is as real a problem as it ever was, and this is no time for complacency.

We should see the Jack well for what it is: desperation. Like the whaling ships of the late 1800s that would sail to the ends of the earth in search of whale oil, Jack is proof positive that we are willing to pay enormous sums and go to extraordinary lengths and depths to get oil. As if the blood of the oil wars wasn’t proof enough.

Chevron said it themselves: The era of cheap oil is, without a doubt, over.

Angel Publishing Investor Club Discord - Chat Now

Brian Hicks Premium


Hydrogen Fuel Cells: The Downfall of Tesla?

Lithium has been the front-runner in the battery technology market for years, but that is all coming to an end. Elon Musk is against them, but Jeff Bezos is investing heavily in them. Hydrogen Fuel Cells will turn the battery market upside down and we've discovered a tiny company that is going to make it happen...

Sign up to receive your free report. After signing up, you'll begin receiving the Energy and Capital e-letter daily.