OilVoice Magazine - August 2015

Edition Forty One - August 2015

The Iraqi-Kurd Oil agreement means dangerous political disagreement

Nine Reasons Why Low Oil Prices May 'Morph' Into Something Much Worse

Oil Price Crash of 2014 / 15 Update

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5

Table of Contents

Nine Reasons Why Low Oil Prices May 'Morph' Into Something Much

Worse

by Gail Tverberg

6


by Euan Mearns

22

Rig Count Increases by 19 As Oil Prices Plunge - What Are They

Thinking?

by Art Berman

29

Cause for Hope in the Levant

by Chris Friedemann

32


by Anthony Franks OBE

37

Has U.S. oil production started to turn down?

by Kurt Cobb

40

Something Solid: World Oil Demand Increases

by Art Berman

42

North Sea could get caught in fallout from Iran nuclear deal

by Alex Russell and Peter Strachan

48

Obama: Iranian oil, good. Canadian oil, bad. American oil, bad.

by Marita Noon

50

6

Nine Reasons Why Low Oil Prices May 'Morph' Into Something Much Worse

Written by Gail Tverberg from Our Finite World

Why are commodity prices, including oil prices, lagging? Ultimately, it comes back to

the question, 'Why isn't the world economy making very many of the end products

that use these commodities?' If workers were getting rich enough to buy new homes

and cars, demand for these products would be raising the prices of commodities

used to build and operate cars, including the price of oil. If governments were rich

enough to build an increasing number of roads and more public housing, there would

be demand for the commodities used to build roads and public housing.

It looks to me as though we are heading into a deflationary depression, because

prices of commodities are falling below the cost of extraction. We need rapidly rising

wages and debt if commodity prices are to rise back to 2011 levels or higher. This

isn't happening. Instead, Janet Yellen is talking about raising interest rates later this

year, and we are seeing commodity prices fall further and further. Let me explain

some pieces of what is happening.

1. We have been forcing economic growth upward since 1981 through the use

of falling interest rates. Interest rates are now so low that it is hard to force

rates down further, to encourage further economic growth.

Falling interest rates are hugely beneficial for the economy. If interest rates stop

dropping, or worse yet, begin to rise, we will lose this very beneficial factor affecting

the economy. The economy will tend to grow even less quickly, bringing down

commodity prices further. The world economy may even start contracting, as it

heads into a deflationary depression.

If we look at 10-year US treasury interest rates, there has been a steep fall in rates

since 1981.

7

In fact, almost any kind of interest rates, including interest rates of shorter terms,

mortgage interest rates, bank prime loan rates, and Moody's Seasoned AAA Bonds,

show a fairly similar pattern. There is more variability in very short-term interest

rates, but the general direction has been down, to the point where interest rates can

drop no further.

Declining interest rates stimulate the economy for many reasons:

Would-be homeowners find monthly payments are lower, so more people can

afford to purchase homes. People already owning homes can afford to 'move

up' to more expensive homes.

Would-be auto owners find monthly payments lower, so more people can

afford cars.

Employment in the home and auto industries is stimulated, as is employment

in home furnishing industries.

Employment at colleges and universities grows, as lower interest rates

encourage more students to borrow money to attend college.

With lower interest rates, businesses can afford to build factories and stores,

even when the anticipated rate of return is not very high. The higher demand

for autos, homes, home furnishing, and colleges adds to the success of

businesses.

8

The low interest rates tend to raise asset prices, including prices of stocks,

bonds, homes and farmland, making people feel richer.

If housing prices rise sufficiently, homeowners can refinance their mortgages,

often at a lower interest rate. With the funds from refinancing, they can

remodel, or buy a car, or take a vacation.

With low interest rates, the total amount that can be borrowed without interest

payments becoming a huge burden rises greatly. This is especially important

for governments, since they tend to borrow endlessly, without collateral for

their loans.

While this very favorable trend in interest rates has been occurring for years, we

don't know precisely how much impact this stimulus is having on the economy.

Instead, the situation is the 'new normal.' In some ways, the benefit is like traveling

down a hill on a skateboard, and not realizing how much the slope of the hill is

affecting the speed of the skateboard. The situation goes on for so long that no one

notices the benefit it confers.

If the economy is now moving too slowly, what do we expect to happen when

interest rates start rising? Even level interest rates become a problem, if we have

become accustomed to the economic boost we get from falling interest rates.

2. The cost of oil extraction tends to rise over time because the cheapest to

extract oil is removed first. In fact, this is true for nearly all commodities,

including metals.

If costs always remained the same, we could represent the production of a barrel of

oil, or a pound of metal, using the following diagram.

9

If production is getting increasingly efficient, then we might represent the situation as

follows, where the larger size 'box' represents the larger output, using the same

inputs.

For oil and for many other commodities, we are experiencing the opposite situation.

Instead of becoming increasingly efficient, we are becoming increasingly inefficient

(Figure 4). This happens because deeper wells need to be dug, or because we need

to use fracking equipment and fracking sand, or because we need to build special

refineries to handle the pollution problems of a particular kind of oil. Thus we need

more resources to produce the same amount of oil.

10

Some people might call the situation 'diminishing returns,' because the cheap oil has

already been extracted, and we need to move on to the more difficult to extract oil.

This adds extra steps, and thus extra costs. I have chosen to use the slightly broader

term of 'increasing inefficiency' because I am not restricting the nature of these

additional costs.

Very often, new steps need to be added to the process of extraction because wells

are deeper, or because refining requires the removal of more pollutants. At times,

the higher costs involve changing to a new process that is believed to be more

environmentally sound.

The cost of extraction keeps rising, as the cheapest to extract resources become

depleted, and as environmental pollution becomes more of a problem.

3. Using more inputs to create the same or smaller output pushes the world

economy toward contraction.

Essentially, the problem is that the same quantity of inputs is yielding less and less

of the desired final product. For a given quantity of inputs, we are getting more and

more intermediate products (such as fracking sand, 'scrubbers' for coal-fired power

plants, desalination plants for fresh water, and administrators for colleges), but we

are not getting as much output in the traditional sense, such as barrels of oil,

kilowatts of electricity, gallons of fresh water, or educated young people, ready to join

the work force.

11

We don't have unlimited inputs. As more and more of our inputs are assigned to

creating intermediate products to work around limits we are reaching (including

pollution limits), less of our resources can go toward producing desired end products.

The result is less economic growth, and because of this declining economic growth,

less demand for commodities. Prices for commodities tend to drop.

This outcome is to be expected, if increased efficiency is part of what creates

economic growth, and what we are experiencing now is the opposite: increased

inefficiency.

4. The way workers afford higher commodity costs is primarily through higher

wages. At times, higher debt can also be a workaround. If neither of these is

available, commodity prices can fall below the cost of production.

If there is a big increase in costs of products like houses and cars, this presents a

huge challenge to workers. Usually, workers pay for these products using a

combination of wages and debt. If costs rise, they either need higher wages, or a

debt package that makes the product more affordable-perhaps lower rates, or a

longer period for payment.

Commodity costs have been rising very rapidly in the last fifteen years or so.

According to a chart prepared by Steven Kopits, some of the major costs of

extracting oil began increasing by 10.9% per year, about 1999.

12

In fact, the inflation-adjusted prices of almost all energy and metal products tended

to rise rapidly during the period between 1999 and 2008 (Figure 7). This was a time

period when the amount of mortgage debt was increasing rapidly as lenders began

offering home loans with low initial interest rates to almost anyone, including those

with low credit scores and irregular income. When buyers began defaulting and debt

levels began falling in mid-2008, commodity prices of all types dropped.

Prices then began to rise once Quantitative Easing (QE) was initiated (compare

Figures 6 and 7). The use of QE brought down medium-term and long-term interest

rates, making it easier for customers to afford homes and cars.

13

More recently, prices have fallen again. Thus, we have had two recent times when

prices have fallen below the cost of production for many major commodities. Both of

these drops occurred after prices had been high, when debt availability was

contracting or failing to rise as much as in the past.

5. Part of the problem that we are experiencing is a slow-down in wage growth.

Figure 8 shows that in the United States, growth in per capita wages tends to

disappear when oil prices rise above $40 barrel. (Of course, as noted in Point 1,

interest rates have been falling since 1981. If it weren't for this, the cut off for wage

growth might even be lower-perhaps even $20 barrel!)

14

There is also a logical reason why we would expect that wages would tend to fall as

energy costs rise. How does a manufacturer respond to the much higher cost of one

or more of its major inputs? If the manufacturer simply passes the higher cost along,

many customers will no longer be able to afford the manufacturer's or service-

provider's products. If businesses can simply reduce some other costs to offset the

rise in the cost in energy products and metals, they might be able to keep most of

their customers.

A major area where a manufacturer or service provider can cut costs is in wage

expense. (Note the different types of expenses shown in Figure 5. Wages are a

major type of expense for most businesses.)

There are several ways employment costs can be cut:

1. Shift jobs to lower wage countries overseas.

2. Use automation to shift some human labor to labor provided by electricity.

3. Pay workers less. Use 'contract workers' or 'adjunct faculty' or 'interns' who

will settle for lower wages.

15

If a manufacturer decides to shift jobs to China or India, this has the additional

advantage of cutting energy costs, since these countries use a lot of coal in their

energy mix, and coal is an inexpensive fuel.

In fact, we see a drop in the US civilian labor force participation rate (Figure 9)

starting at approximately the same time when energy costs and metal costs started

to rise. Median inflation-adjusted wages have tended to fall as well in this period.

Low wages can be a reason for dropping out of the labor force; it can become too

expensive to commute to work and pay day care expenses out of meager wages.

Of course, if wages of workers are not growing and in many cases are actually

shrinking, it becomes difficult to sell as many homes, cars, boats, and vacation

cruises. These big-ticket items create a significant share of commodity 'demand.' If

workers are unable to purchase as many of these big-ticket items, demand tends to

fall below the (now-inflated) cost of producing these big-ticket items, leading to the

lower commodity prices we have seen recently.

16

6. We are headed in slow motion toward major defaults among commodity

producers, including oil producers.

Quite a few people imagine that if oil prices drop, or if other commodity prices drop,

there will be an immediate impact on the output of goods and services.

Instead, what happens is more of a time-lagged effect (Figure 11).

Part of the difference lies in the futures markets; companies hold contracts that hold

sale prices up for a time, but eventually (often, end of 2015) run out. Part of the

17

difference lies in wells that have already been drilled that keep on producing. Part of

the difference lies in the need for businesses to maintain cash flow at all costs, if the

price problem is only for a short period. Thus, they will keep parts of the business

operating if those parts produce positive cash flow on a going-forward basis, even if

they are not profitable considering all costs.

With debt, the big concern is that the oil reserves being used as collateral for loans

will drop in value, because of the lower price of oil in the world market. The collateral

value of reserves works out to be something like (barrels of oil in reserves x some

expected price).

As long as oil is being valued at $100 barrel, the value of the collateral stays close to

what was assumed when the loan was taken out. The problem comes when low oil

prices gradually work their way through the system and bring down the value of the

collateral. This may take a year or more from the initial price drop, because prices

are averaged over as much as 12 months, to provide stability to the calculation.

Once the value of the collateral drops below the value of the outstanding loan, the

borrowers are in big trouble. They may need to sell other assets they have, to help

pay down the loan. Or they may end up in bankruptcy. The borrowers certainly can't

borrow the additional money they need to keep increasing their production.

When bankruptcy occurs, many follow-on effects can be expected. The banks that

made the loans may find themselves in financial difficulty. The oil company may lay

off large numbers of workers. The former workers' lack of wages may affect other

businesses in the area, such as car dealerships. The value of homes in the area may

drop, causing home mortgages to become 'underwater.' All of these effects

contribute to still lower demand for commodities of all kinds, including oil.

Because of the time lag problem, the bankruptcy problem is hard to reverse. Oil

prices need to stay high for an extended period before lenders will be willing to lend

to oil companies again. If it takes, say, five years for oil prices to get up to a level

high enough to encourage drilling again, it may take seven years before lenders are

willing to lend again.

7. Because many 'baby boomers' are retiring now, we are at the beginning of a

demographic crunch that has the tendency to push demand down further.

18

Many workers born in the late 1940s and in the 1950s are retiring now. These

workers tend to reduce their own spending, and depend on government programs to

pay most of their income. Thus, the retirement of these workers tends to drive up

government costs at the same time it reduces demand for commodities of all kinds.

Someone needs to pay for the goods and services used by the retirees. Government

retirement plans are rarely pre-funded, except with the government's own debt.

Because of this, higher pension payments by governments tend to lead to higher

taxes. With higher taxes, workers have less money left to buy homes and cars. Even

with pensions, the elderly are never a big market for homes and cars. The overall

result is that demand for homes and cars tends to stagnate or decline, holding down

the demand for commodities.

8. We are running short of options for fixing our low commodity price problem.

The ideal solution to our low commodity price problem would be to find substitutes

that are cheap enough, and could increase in quantity rapidly enough, to power the

economy to economic growth. 'Cheap enough' would probably mean approximately

$20 barrel for a liquid oil substitute. The price would need to be correspondingly

inexpensive for other energy products. Cheap and abundant energy products are

needed because oil consumption and energy consumption are highly correlated. If

prices are not low, consumers cannot afford them. The economy would react as it

does to inefficiency.

19

These substitutes would also need to be non-polluting, so that pollution workarounds

do not add to costs. These substitutes would need to work in existing vehicles and

machinery, so that we do not have to deal with the high cost of transition to new

equipment.

Clearly, none of the potential substitutes we are looking at today come anywhere

close to meeting cost and scalability requirements. Wind and solar PV can only built

on top of our existing fossil fuel system. All evidence is that they raise total costs,

adding to our 'Increased Inefficiency' problem, rather than fixing it.

Other solutions to our current problems seem to be debt based. If we look at recent

past history, the story seems to be something such as the following:

Besides adopting QE starting in 2008, governments also ramped up their spending

(and debt) during the 2008-2011 period. This spending included road building, which

increased the demand for commodities directly, and unemployment insurance

payments, which indirectly increased the demand for commodities by giving jobless

people money, which they used for food and transportation. China also ramped up

its use of debt in the 2008-2009 period, building more factories and homes. The

combination of QE, China's debt, and government debt brought oil prices back up by

2011, although not to as high a level as in 2008 (Figure 7).

More recently, governments have slowed their growth in spending (and debt),

realizing that they are reaching maximum prudent debt levels. China has slowed its

debt growth, as pollution from coal has become an increasing problem, and as the

need for new homes and new factories has become saturated. Its debt ratios are

also becoming very high.

QE continues to be used by some countries, but its benefit seems to be waning, as

interest rates are already as low as they can go, and as central banks buy up an

increasing share of debt that might be used for loan collateral. The credit generated

by QE has allowed questionable investments since the required rate of return on

investments funded by low interest rate debt is so low. Some of this debt simply

recirculates within the financial system, propping up stock prices and land prices.

Some of it has gone toward stock buy-backs. Virtually none of it has added to

commodity demand.

20

What we really need is more high wage jobs. Unfortunately, these jobs need to be

supported by the availability of large amounts of very inexpensive energy. It is the

lack of inexpensive energy, to match the $20 oil and very cheap coal upon which the

economy has been built, that is causing our problems. We don't really have a way to

fix this.

9. It is doubtful that the prices of energy products and metals can be raised

again without causing recession.

We are not talking about simply raising oil prices. If the economy is to grow again,

demand for all commodities needs to rise to the point where it makes sense to

extract more of them. We use both energy products and metals in making all kinds of

goods and services. If the price of these products rises, the cost of making virtually

any kind of goods or services rises.

Raising the cost of energy products and metals leads to the problem represented by

Growing Inefficiency (Figure 4). As we saw in Point 5, wages tend to go down, rather

than up, when other costs of production rise because manufacturers try to find ways

to hold total costs down.

Lower wages and higher prices are a huge problem. This is why we are headed back

into recession if prices rise enough to enable rising long-term production of

commodities, including oil.

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22


Written by Euan Mearns from Energy Matters

Towards the end of last year I had a couple of posts, the first explaining the oil price

crash of 2014 in terms of a simple supply - demand model and the second using this

model to anticipate where the oil price may head in 2015 and 2016. In light of the

supply, demand and price action of the last six months both of these posts now need

to be updated and revised.

The 2014 Oil Price Crash Explained

Oil Price Scenarios for 2015 and 2016

In my Price Scenarios post I forecast a Brent price of $56.50 for December 2015 and

with Brent spot currently around $60 this is looking quite good. So far this is panning

out in the right direction but for the wrong reasons which does not count as being

correct in my book.

Figure 1

The raw oil price and production monthly data that lies behind the model can be

23

divided into 7 legs. 1) Jan 2002 to April 2004 oil supply was elastic allowing demand

to grow with little impact on price...

Figure 2 The supply and demand curves are based on a model first proposed by

Phil Hart in an Oil Drum post from 2009 (link no longer working). Supply, fitted to the

data, changes from elastic (low gradient) to inelastic (steep positive gradient).

Demand (conceptual) is inelastic with steep negative gradient, i.e. high price will

suppress demand but not by a lot. The price is struck where the supply and demand

curves intercept. The movement of the inelastic parts of the supply and demand

curves relative to each other can result in large movements in price for relatively

small movements in supply or demand. The grey line shows how demand increased

from 2004 to 2008 against inelastic supply sending the price sharply upwards (the

intersection of the two curves, supply and demand, should always be balanced by

price.)

2) May 2004 to July 2008, OPEC spare capacity shrank and demand continued to

rise against inelastic supply sending the monthly average price up from $34 to $133 /

bbl (Figure 2)

24

Figure 3 Between August 2008 and February 2009 demand collapsed, in part due to

the unwinding of speculative positions, sending the oil price back to from whence it

came.

3) Aug 2008 to February 2009, the financial crash, in part caused by high energy

prices, saw demand collapse and the price retraced its ascent falling from $133 to

$43 / bbl (Figure 3).

4) Mar 2009 to May 2011, QE, debt inflation, OPEC supply reduction and overall

management of our not so free markets saw the oil price recover to $123 / bbl

(Figure 1).

5) Jun 2011 to Jun 2014, the impact of shale drilling in the USA began to feed

through to rapid supply growth which once again became elastic allowing demand to

increase with little impact upon price (Figure 1).

25

So far so good, these are the sequence of events described in my earlier posts. It is

what happened next that is seriously at odds with my forecast. My 2015 / 16 price

forecast was largely based on assumption that we were witnessing history repeat

and that price collapse was to a large extent driven by weak demand combined with

OPEC's decision to abandon the policy of restraint. What has happened can in fact

be explained by over-supply alone.

Figure 4 Since 2008 oil supply grew significantly, hence the supply curves have

moved to the right. A significant increase in supply between August 2014 and

January 2015 (grey curve) not met by an increase in demand, sent the oil price into a

tail spin.

6) August 2014 to present saw supply increase from 93.1 to 96.1 Mbpd. A 3 million

bpd supply increase against weak / static demand sent the price crashing down.

Where did this oil come from? In the past OPEC have cut supply by at least 3 Mbpd

to support price and their failure to do so this time is sufficient explanation. If one

26

needs further convincing of the over-supply argument, US production has risen by

over 1 Mbpd from August 2014 to May 2015. There remains a weak demand

component to the story in that in past cycles OPEC has managed weak demand by

cutting supply. This time they have not resulting in over-supply.

Figure 5

7) The final part of the story is that demand has risen, stimulated by low price, to

mop up that extra supply and providing the recent support to the oil price, driving

Brent back over $60 / bbl (Figure 5).

What Was Wrong With Earlier Scenarios

There were two main problems with my Oil Price Scenarios for 2015 and 2016 post.

The first is that I anticipated weak demand but went further and assumed that

demand would fall as in 2008 and this would be the principle mechanism for price

collapse. While demand then probably was weak, it did not fall. The second is that

while I anticipated that supply may not fall for over a year, I did not anticipate the

momentum for supply growth. Hence, the price movement thus far is largely as

anticipated, but it has come about by supply growth and not a fall in demand.

27

What next?

It has always been a fickle black art to try and forecast the oil price. One of the first

points to recognise is that the demand curve shown in all my charts, derived

empirically from the 2002 to 2008 data may no longer apply. The Global economy is

littered with mine fields, the main one staring Europe in the face is GREXIT. The

second is unsustainable debt levels in many major economies starting with Japan,

followed by Italy, France, the UK, the USA and China. And there are geopolitical

scars from the early skirmishes of WWIII all around the borders of Europe. These

negative factors need to be weighed against the warm glow of cheap oil flowing

through the global economy. I find it impossible to judge the balance between these

forces.

On the supply front, it was widely anticipated that the collapse in US drilling would

bring about a fall in LTO production by this summer that has so far failed to

materialise. The US oil rig count is stabilising at the 600+ level and I am beginning to

wonder if this might not be sufficient to sustain production levels. A significant drop

might not occur. And thus far, significant falls in production have failed to materialise

anywhere.

My Oil Price Scenarios for 2015 and 2016 anticipated a significant drop in production

in 2016 that would send the price back up towards $100. Now I'm not so sure. The

momentum built in recent years on the back of high price may take more than 12 to

18 months to dissipate. The industry is doing all it can to cut costs in order to adjust

to the lower price environment. Those companies locked into high cost

developments will pour gasoline on the bonfire and may have to chew losses for a

number of years.

Recent history has not repeated and that makes it nigh impossible to predict the

future with so many unconstrained variables.


Energy Matters

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29

Rig Count Increases by 19 As Oil Prices Plunge - What Are They Thinking?

Written by Art Berman from The Petroleum Truth Report

The U.S. rig count increased by 19 this week as oil prices dropped below $48 per

barrel-the latest sign that the E&P industry is out of touch with reality.

The last time the rig count increased this much was the week ending August 8, 2014

when WTI was $98 and Brent was $103 per barrel.

What are they thinking?

Figure 1. Daily WTI crude oil prices, January 2-July 24, 2015. Source: EIA and

NYMEX futures prices (July 21-24).

In fairness, the contracts to add more rigs were probably signed in May and June

when WTI prices were around $60 per barrel (Figure 1) and some felt that a bottom

had been found, left behind in January through March, and that prices would

continue to increase.

Even then, however, the fundamentals of supply, demand and inventories pointed

30

toward lower prices-and still, companies decided to add rigs.

In mid-May, I wrote in a post called 'Oil Prices Will Fall: A Lesson in Gravity',

'The data so far says that the problem that moved prices to almost $40 per barrel in

January has only gotten worse. That means that recent gains may vanish and old

lows might be replaced by lower lows.'

In mid-June, I wrote in a post called 'For Oil Price, Bad Is The New Good',

'Right now, oil prices are profoundly out of balance with fundamentals. Look for a

correction.'

Oil prices began falling in early July and fell another 6% last week. Some of that was

because of the Iran nuclear deal, the Greek debt crisis and the drop in Chinese stock

markets. But everyone knew that the first two were coming, and there were plenty of

warnings about the the Chinese stock exchanges long before July.

The likelihood of lower oil prices should not have been a surprise to anyone.

Of the 19 rigs added this week, 12 were for horizontal wells (Figure 2) and 7 of those

were in the Bakken, Eagle Ford and Permian plays that account for most of the tight

oil production in the U.S.

Figure 2. Rig count

change table for

horizontal wells.

Source: Baker-

Hughes and Labyrinth

Consulting Services,

Inc.

31

Horizontal shale gas plays added 8 rigs. That is as out-of-touch as the tight oil rig

additions since gas prices averaged only $2.75 in the second quarter of 2015 (Figure

3) and are almost half of what they were in the first quarter of 2014.

Figure 3. Henry Hub natural gas daily prices and quarterly average prices.

Source: EIA and Labyrinth Consulting Services, Inc.

The U.S. E&P industry is really good at spending other people's money to increase

production. It doesn't matter if there is a market for the oil and gas. As long as the

capital keeps flowing, they will do what they do best.

Don't be distracted by the noisy chatter about savings through efficiency or re-

fracking. Just look at the income statements and balance sheets from first quarter

and it's pretty clear that most companies are hemorrhaging cash at these prices.

Second quarter is likely to be worse and it gets uglier when credit is re-determined in

Q3, hedges expire, and reserves are written down after Q4.

This is an industry in crisis despite the talk about showing OPEC a thing or two about

American ingenuity. Increasing drilling when you're losing money and prices are

falling doesn't sound very ingenious to anyone.

Watch for the markets to agree as oil prices fall lower in coming weeks.


The Petroleum Truth Report

32

Cause for Hope in the Levant

Written by Chris Friedemann from NEOS

The Eastern Mediterranean region has drawn a great deal of interest in recent years,

and not just because of the dynamic geo-political situation in the region. The

petroleum industry has been watching the region with a keen eye, as exploration

successes in the offshore waters of the EastMed have many intrigued by the

potential riches to be unlocked in this newly emerging hydrocarbon province. Noble

Energy's 2010 discovery of the Leviathan field and the reported 16 trillion cubic feet

(TCF) of natural gas it contains captured the attention of explorationists worldwide.

Other discoveries in the EastMed, including that of the 5-10 TCF Aphrodite field in

Cyprus' territorial waters, have only added to the fervor.

While these recent offshore discoveries make it appear that the EastMed is one of

the newest regions on the global hydrocarbon stage it is, in fact, one of the oldest.

Syria has a hydrocarbon history that dates back to the days of Antiquity when

bitumen on the surface was used to lubricate stone tools and to waterproof crop

baskets. Just a few years ago, Syria was producing 400,000 barrels of oil per day. At

2.5 billion barrels, Syria possessed the largest hydrocarbon reserves of any producer

in the greater Levant region, excepting Iraq.

Sitting squarely in the center of all this activity is Lebanon, a country known for its

rich cultural history and vibrant tourist sector. What Lebanon has not been known for,

however, is the production of oil and gas. Only seven wells have ever been drilled in

the country, all of them onshore and none of them having ever produced in

commercial quantities.

Interest began to build in Lebanon's hydrocarbon potential several years ago, with

the initial focus on the country's offshore prospects in the EastMed just northeast of

the Leviathan and Aphrodite discoveries. Spectrum Geophysical and PGS

collectively acquired 14,000 line-km of 2-D and 14,000 km2 of 3-D seismic data. To

date, not a single well has been drilled nor has a single lease block even been

awarded as political wrangling has drawn the entire offshore block bidding process to

a virtual standstill.

33

Having enriched the country's offshore geophysical database, the Lebanese

Petroleum Administration (LPA) turned its attention to gathering geophysical

measurements and assessing the hydrocarbon potential of the country's onshore

basins. Initially, the plan was to acquire several hundred line-km of 2-D seismic.

However, those plans were scaled back and ultimately never implemented because

of the challenges to terrestrial geophysical acquisition posed by Lebanon's

topography. The country's natural beauty - shaped by rocky hillsides, deep ravines

and even snow-capped, 2,500 meter mountains - are not well suited to seismic

vibrator trucks or dozens of juggies hauling tons of seismic acquisition gear.

6,000 km2 survey area covering the

northern onshore region and near-shore

waters of the Eastern Mediterranean.

To sidestep these challenges, the LPA turned to NEOS GeoSolutions and its local

Lebanese partner, Petroserv, to propose an alternative path. The Plan B option that

was identified involved acquiring a suite of airborne geophysical measurements -

including gravity, magnetic, radiometric and hyperspectral - complemented by sub-

surface regional resistivity data acquired using ground-based magnetotelluric (MT)

receivers. The two-month acquisition operation over a 6,000 km2 area of

investigation in the northern onshore portion of the country and its near-shore

coastal waters concluded earlier this year. Once processed, the acquired

measurements were integrated and simultaneously interpreted with other legacy

G&G datasets, including logs from two of the wells in the study area along with some

of the offshore seismic data.

34

Airborne hyperspectral imaging

revealed direct and indirect

hydrocarbon indicators, including oil

seeps, over a large portion of the

survey area.

The results, which were shared with the LPA and several cabinet ministers in June,

appear very promising. Perhaps the biggest surprise came from the hyperspectral

measurements, which are used to search for indirect and direct hydrocarbon

indicators on the surface. The hyperspectral data identified mineral alteration zones

often associated with hydrocarbon micro-seepage in large parts of the survey area.

Even more telling, the hyperspectral data indicated a large expanse of oil seeps

throughout much of the area of investigation. The sheer number of these seeps and

their locations along newly mapped fault networks and along the boundaries of key

stratigraphic intervals suggest we are dealing with an active (and potentially liquids-

prone) hydrocarbon-generating system beneath Lebanon.

Peering down into the subsurface, the interpretation of the multi-physics

measurements revealed some other intriguing attributes often associated with

prospective frontier exploration areas. These include:

Evidence of multiple source rock intervals, including those believed to be

hydrocarbon-generating in Syria and in the Southern Levant immediately

south of Lebanon;

Evidence of sedimentary depo-centers, reservoir rocks, and typical structural

trapping mechanisms such as anticlinal closures and prospective reservoir

intervals abutting faults;

35

Evidence of resistivity anomalies within several of the structural traps,

potentially indicative of hydrocarbon charge within the prospective reservoir

intervals.

Multi-physics modeling work revealed several promising structural features, including

anticlinal highs (adjacent to faults) in the thick Triassic and Paleozoic intervals.

The features noted above were observed at different intervals within the geologic

column and in different parts of the area of investigation - including along the near-

shore coastal waters of Lebanon - suggesting a variety of potential exploration play

types (including both gas and oil plays) might exist in the country. The multitude of

plays and the stacked nature of a couple of them - all of them now highgraded

following this project - serve to de-risk the overall exploration opportunity.

Although Lebanon is in the earliest stages of the exploration cycle, the initial

promising results of the multi-physics project appear to support additional

investments in data gathering - including targeted seismic acquisition - and G&G

analysis to further highgrade the opportunity areas and to identify potential prospects

for an initial wave of exploratory drilling. More remains to be done to de-risk the plays

in Lebanon, but we may finally have a cause for hope in this part of the Levant and

be able to celebrate the birth of this great country's oil and gas industry.


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37


Written by Anthony Franks OBE from Mars Omega LLP

The oil agreement between Baghdad and Irbil is under dangerous pressure, and

constitutes a clear risk to the economic and political stability of both Iraq and

Kurdistan.

It is for this reason that US Ambassador Stuart Johns hurried to Irbil earlier this week

for a meeting with President Barzani. Ostensibly the discussions were to encourage

closer operational coordination between the Peshmerga and the Iraqi armed forces,

but a priority was to try to defuse the ticking time-bomb of independent Kurdish oil

sales.

An MP for the Kurdish Alliance, Salim Shawqi, believes that dialogue will remove

misunderstanding between both governments. He said 'The collapse of the oil

agreement will affect both Baghdad and Irbil, because the central government needs

the oil revenges and Kurdish unilateral oil exports will lead to nowhere, because the

oil exports are illegitimate and secretly done.'

Shawqi explained that the oil agreement between the two capitals stipulated the

export of 550K bpd as being 'sharp' whereas Irbil says the figure should only be an

average, as Kurdistan has experienced technical problems in production.

Baghdad is insisting that the daily exports from Kurdistan should be exactly 550K

bpd as a result of the decline in global oil prices - they are looking to raise revenue

through high volume - low margin sales. And the recent US decision on the probable

lifting of sanctions on Iran is only going to make that situation more complex as

Tehran opens the spigots.

38

The Kurds say that Baghdad has not honoured the agreement to transfer the

appropriate cash for oil produced to fund the KRG and the Peshmerga's fight against

ISIS, they decided on 1 July 2015 to export their oil directly.

There is a clear economic and political risk. The Chairman of the Iraqi Parliamentary

Oil and Gas Committee, Ariz Abdullah, says that the move by the KRG directly to

export the oil is 'the start to divide Iraq' - a comment which will have caused alarm

bells to ring in boardrooms across the world, as executives try to work through what

the implications of such a division might mean.

However, it would be premature to believe that there is unity in the KRG towards this

issue - there is not. The Politbureau of the Kurdish National Union Party (KNU) has

called upon the KRG to continue to export oil through the Iraqi State Oil Marketing

Company (SOMO), even though Baghdad is in arrears of payments for oil already

produced.

MP Tariq Kurdi who sits on the Oil and Gas Commission is critical of the KNU

stance, as he believes that the KRG has been forced down the road of independent

production by Baghdad.

The KRG has big bills to pay: not only its day to day running costs, but it is footing

the bill of hundreds of thousands of displaced persons, many of whom are Iraqi.

According to information provided by the Kurdish Ministry of Natural Resources, Irbil

has handed over 54M barrels of crude since January 2015 as well as 24M barrels

from Kirkuk.

The KRG expects Baghdad to pay them 1.2T Iraqi dinars per month, but says

Baghdad is not doing so, and this is exponentially increasing the financial pain it is

feeling.

39

And this pain is leading the KRG to examine a different future: a future that does not

involve political interference from Baghdad in Irbil's economic policy or political

decisions.

The Kurdish Minister of Finance, Fadhil Nabi, has suggested that the Kurds would be

able to sell their oil independently but at the same time retain a share of the federal

Iraqi budget whilst paying an element of the Kirkuk budget.

This is likely to be seen as a highly contentious proposal by Baghdad, which is

desperate to retain control of the super-giant oil field of Kirkuk.

Despite political misgivings by some of the Kurdish parties, Irbil is slowly but surely

cruising towards independence. An understandably reticent political source argues

that the KRG can 'benefit from the security, political and sectarian chaos in the Arab

part of Iraq' in order to expand Kurdistan's geographical boundaries, as well as its

economic boundaries by annexing Kirkuk and other disputed areas.

Such a move would allow Irbil to follow its dream of a separate sovereign state; but

such a move is likely to be viewed with alarm and deep concern by Kurdistan's

neighbours, all of whom fear the creation of a much broader and deeper Kurdish

state that would undermine the territorial integrity of Iran, Syria and Turkey.

We understand that the Iraqi Minister of Oil, Adil Abdul Mahdi will shortly appear in

front of the Iraqi Parliament to explain why the oil agreement with the KRG is in fact

more of a highly dangerous political disagreement and one which might see Iraq

fracture down ethnic as well as hydrocarbon faultlines.


Mars Omega LLP

40

Has U.S. oil production started to turn down? Written by Kurt Cobb from Resource Insights

The plunge in oil prices last year led many to say that a decline in U.S. oil production

wouldn't be far behind. This was because almost all the growth in U.S. production in

recent years had come from high-cost tight oil deposits which could not be profitable

at these new lower oil prices. These wells were also known to have production

declines that averaged 40 percent per year. Overall U.S. production, however,

confounded the conventional logic and continued to rise--until early June when it

stalled and then dropped slightly.

Anyone who understood that U.S. drillers in shale plays had large inventories of

drilled, but not yet completed wells, knew that production would probably rise for

some time into 2015--even as the number of rigs operating plummeted. Shale drillers

who are in debt--and most of the independents are heavily in debt--simply must get

some revenue out of wells already drilled to maintain interest payments. Some oil

production even at these low prices is better than none. Only large international oil

companies--who don't have huge debt loads related to their tight oil wells--have the

luxury of waiting for higher prices before completing those wells.

The drop in overall U.S. oil production (defined as crude including lease condensate)

is based on estimates made by the U.S. Energy Information Administration (EIA).

Still months away are revised numbers based on more complete data. But, the EIA

had already said that it expects U.S. production to decline in the second half of this

year.

What this first sighting of a decline suggests is that glowing analyses of how much

costs have come down for tight oil drillers and how much more efficient the drillers

have become with their rigs are off the mark. It was inevitable that oil service

companies would be forced to discount their services to tight oil drillers in the wake

of the price and drilling bust or simply go without work. And, it makes sense that the

most inefficient uses of drilling rigs would be halted.

41

But the idea that these changes would somehow allow tight oil drillers to continue

without missing a beat were always bunkham promoted by an industry sinking into a

mire of overindebedness in the face of lower prices. In order to maintain the flow of

capital to the industry--which has consistently spent more cash than it generates--the

illusion of profitability had desperately to be maintained. A recent renewed slump in

the oil price may finally pierce that illusion among investors.

As Iranian oil exports start to ramp up in the wake of an agreement on nuclear

weapons--the Iranians aren't allowed to have any--and the resulting end of economic

sanctions, the oil price is likely to fall further, putting even more pressure on U.S.

domestic drillers.

OPEC, which has refused to reduce output in the face of slackening world oil

demand growth, continues to say that others--such as U.S. tight oil drillers--will have

to 'balance the market,' a euphemism for cutting production in order to push up

prices.

It looks as if U.S. drillers may finally be doing just that. Who knew that 45 years after

abandoning the role of the world's swing producers*--that is, producers who adjust

production up or down to maintain stable world oil prices--U.S. oil companies would

be forced into that role again entirely against their will?

*The state of Texas was the world's swing producer up until 1970 through a

mechanism called proration. The state regulated the percentage of maximum flow

from oil wells in order to adjust production and thus keep prices within a band that

made drilling profitable without jeopardizing demand for oil. In fact, the proration

program administered by the Railroad Commission of Texas became a model for

OPEC.


Resource Insights

42

Something Solid: World Oil Demand Increases

Written by Art Berman from The Petroleum Truth Report

Traders were busy throwing in the towel on oil futures this week just as the first solid

data and hope appeared that oil prices may be starting on the long road to recovery.

As oil prices approached $52 per barrel on Tuesday, July 7, the EIA released the

July Short-term Energy Outlook (STEO) that showed an increase in global demand.

Figure 1. New York Mercantile Exchange crude oil futures, Continuous Contract #1

(CL1) (Front Month).

Source: Quandl

Global liquids demand increased 1.26 mmbpd (million barrels per day) compared to

May (Figure 2).

43

Figure 2. World Liquids Supply and Demand, July 2013-June, 2015.


This is the first data to support a potential recovery in oil prices. For months, great

attention was focused on soft measures like rig count, crude oil inventories and

vehicle miles traveled, all in the United States. These are potential indicators of

future demand but hardly the kind of data that should have moved international oil

prices from $47 in January to $64 in May.

The relative production surplus (production minus consumption) moved down to 1.9

mmbpd (Figure 3).

44

Figure 3. World liquids production surplus or deficit (total production minus

consumption) and Brent crude oil price in 2015 dollars.


That is certainly good news but an over-supply of almost 2 mmbpd is hardly cause

for celebration. The new demand data from EIA brings over-production of liquids

back into the October 2014 to January 2015 range that resulted in Brent oil prices

falling from $87 to $48 per barrel.

Oil prices dropped sharply this week as news of the Greek financial crisis and the

free fall of Chinese stock exchanges suggested weaker demand for oil as the global

economy falters. The EIA demand data does nothing to change this troubling

economic outlook but it does confirm the seemingly obvious notion that low oil prices

result in greater consumption.

In recent posts, I have emphasized that falling global demand for oil is key to

OPEC's strategy to keep prices low for some time. The July STEO underscores this

problem for two key markets-the Asia-Pacific region-29% of world consumption-that

includes China, Japan and India, and the United States-21% of world consumption.

Growth in Asia has slowed from 7% annually in 2012 to only 2% today (Figure 4).

45

Figure 4. Asia-Pacific liquids consumption and year-over-year change.


While somewhat less alarming than Asia, U.S. growth has slowed from 6.5%

annually in 2013 to about 4% today (Figure 5).

46

Figure 5. U.S. liquids consumption and year-over-year change.


U.S. crude oil production declined a mere 40,000 barrels per day in June (Figure 6).

U.S. production fell 120,000 bpd in January. That was an good sign that the global

over-supply would be alleviated sooner than later so prices could recover.

Figure 6. U.S. crude oil production.


Then, an increase in prices in February and exceptional capital flow to U.S. tight oil

companies resulted in increased U.S. production in February, March and April.

Company executives boast about the resilience of U.S. tight oil production as if over-

production and low prices are something they are proud of and that their

shareholders value.

ConocoPhillips CEO Ryan Lance made macho proclamations at the OPEC meeting

in June that tight oil 'is here to stay,' single-handedly undermining the remote

possibility that a production cut might result from the cartel's meeting.

U.S. E&P companies should get realistic about the situation they are in. Price will win

this game. OPEC holds those cards for now.


The Petroleum Truth Report

48

North Sea could get caught in fallout from Iran nuclear deal

Written by Alex Russell and Peter Strachan from

Robert Gordon University - Energy Centre

As intense negotiations continue in Vienna with the world's superpowers (Britain,

China, France, Germany, Russia and the US) Iran has still to conclude a deal that

ensures absolute transparency on its nuclear plant activities that should prevent it

acquiring nuclear weapons.

That result would be good news and the world a safer place as a consequence. In

return, sanctions against the free development of Iran's oil and gas reserves will be

removed. How would this impact on the world's political and economic scene?

With low oil prices now seemingly a fixture for the foreseeable future the prospect a

huge increase in oil output from Iran must send a shiver down the spine of countries

whose oil industries are already teetering on the brink of collapse.

For example, can the North Sea oil industry withstand any further fall in the price of

oil?

It is possible that once output from Iran reaches, or more likely surpasses, its 2011

output of 3.6million barrels of oil per day the price of oil could fall as low as $20 a

barrel.

It may take up to a year for that to happen as Iran will need the help of the oil majors

to maximise its output.

But at $20 a barrel the North Sea game would appear to be over and

decommissioning would be order of the day. Low oil prices would have a positive

effect on the economy of the UK as a whole that would help compensate for the

decline in the upstream oil sector.

49

In Aberdeen, the dynamics of the industry would change. There would be huge

potential for the supply chain to become involved in decommissioning, the total cost

of which is likely to be in the region of 80billion. The Oil and Gas Authority has

already positioned itself to help the industry through that phase.

Would the Organisation of Petroleum Exporting Countries (OPEC), of which Iran is a

member, allow oil to fall to $20 a barrel?

Everything else being equal the answer is a resounding 'no'.

But recent actions of Saudi Arabia, the most influential member of OPEC, in its

apparent conflict with its US ally over primacy in oil production casts doubt on its

desire to keep oil prices at a higher level. Why is that the case? Alas, the other great

game being played is the US economic war against Russia.

The country to suffer most from a very low oil price is Russia; its economy could not

survive oil at $20 a barrel. If Russia is brought to heel and its ambitions in the

Ukraine tempered then normality could return to the oil price setting mechanism.

The big question is will that happen in time to save the North Sea oil industry and the

oil industries of a host of other countries such as Nigeria?

Part of any deal between Iran and the superpowers will include an understanding

that Iran will not be an onlooker in degrading and removing the firepower of the so

called Islamic State (Isis) in Iraq and in Syria.

Indeed Iran itself will be a target in the sights of the Sunni-based Isis with its hatred

of Shi'is-based Iran. The US and Saudi Arabia will welcome help from any quarter in

its war with Isis. Such collaboration amongst otherwise implacable enemies has

been a characteristic of the history of the Middle East.

If there had been no internal and external squabbling amongst Iraq, Iran, Saudi

Arabia, Syria and Kuwait then those countries arguably could now be rulers of the

world in economic terms. But that is something for historians to ponder over.


Robert Gordon University - Energy Centre

50

Obama: Iranian oil, good. Canadian oil, bad. American oil, bad. Written by Marita Noon from Energy Makes America Great

President Obama's confusing approach to energy encourages our enemies who

shout 'death to America,' while penalizing our closest allies and even our own job

creators.

Iran's participation in the nuclear negotiations that have slogged on for months, have

now, ultimately, netted a deal that will allow Iran to export its oil-which is the only

reason they came to the table (they surely are not interested in burnishing Obama's

legacy). International sanctions have, since 2011, cut Iran's oil exports in half and

severely damaged its economy. Iran, it is estimated, currently has more than 50

million barrels of oil in storage on 28 tankers at sea-part of a months' long build up.

It is widely reported that, due to aging infrastructure and saturated storage, it will

take Iran months to bring its production back up to pre-sanction levels. The millions

of barrels of oil parked offshore are indicative of their eagerness to increase exports.

Once the sanctions are lifted-if Congress approves the terms of the deal, Iran wants

to be ready to move its oil. In fact, even before the sanctions have been lifted, Iran is

already moving some of its 'floating storage.' On July 17, the Financial Times (FT)

reported: 'The departure of a giant Iranian supertanker from the flotilla of vessels

storing oil off the country's coast has triggered speculation Tehran is moving to ramp

up its crude exports.' The Starla, 'a 2 million barrel vessel,' set sail-moving the oil

closer to customers in Asia. In April, another tanker, Happiness, sailed from Iran to

China, where, since June, it has parked off the port City of Dalian.

Starla is the first vessel storing crude offshore to sail after the nuclear deal was

reached-which is, according to the FT: 'signaling its looming return to the oil market.'

Reuters calls its departure: 'a milestone following a months-long build-up of idling

crude tankers.' Analysts at Macquarie Capital, apparently think the oil on Starla will

not be parked, waiting for sanctions to be lifted. A research note, states: Iran is 'likely

51

assuming that either a small increase in exports will not undermine the historic

accord reached or that no one will notice.' We noticed.

Already, before sanctions are lifted, global oil prices are feeling the pressure of Iran's

increased exports. Since the deal's been announced, crude prices have lost almost

all of the recent gains. While the Obama Administration's actions are allowing Iran,

which hates America, to boost its economy by increasing its oil exports, they are

hurting our closest ally but putting delay after delay in front of the Keystone pipeline-

which would help Canada export its oil.

After six-and-a-half years of kicking the can down the road, and despite widespread

support and positive reports, the Keystone pipeline is no closer to construction than it

was on the day the application was submitted. It is obvious President Obama doesn't

like the project, which will create tens of thousands of jobs, according to his own

State Department. Back in February, he vetoed the bill Congress sent him that would

have authorized construction, saying that it circumvented 'longstanding and proven

processes for determining whether or not building and operating a cross-border

pipeline serves the national interest.' At the time, Senate Majority Leader Mitch

McConnell (R-KY) said: 'Congress won't stop pursuing good ideas, including this

one.' But he was not able to gather enough votes to override the veto and, since

then, we've heard nothing about the Keystone pipeline. In Washington, DC, silence

on an important issue like Keystone isn't always golden.

There is no pending legislation on Keystone, but the permit application has still not

been approved or rejected. I had hoped that the unions, who want the jobs Keystone

would provide, would be able to pressure enough Democrats to support the project,

to push a bill over the veto-proof line. But that didn't happen. For months, Keystone

has been silently dangling. But that may be about to change.

Reliable sources tell me that Obama is prepared to, finally, announce his decision on

Keystone. According to the well-sourced, and verified, rumor, he is going to say:

'No'-probably just before or after the Labor Day holiday. He'll conclude that it is not in

the 'national interest.' So helping our ally grow its economy and export its oil is not in

our national interest but helping our sworn enemy do the same, is? It's like the

52

'Channeling Jeff Foxworthy' parody states: we just 'might live in a country founded by

geniuses and run by idiots.'

Speaking of economic growth and oil exports, what about here at home, in the good

old U.S. of A.? Senator Lisa Murkowski (R-AK) questions the deal that allows Iran to

export its oil, while we cannot: 'As Congress begins its 60-day review of President

Obama's nuclear deal with Iran, there are plenty of reasons to be skeptical about

whether it is in our nation's-and the world's-best interests. Not least among them are

the underexplored, but potentially significant consequences the deal will hold for

American energy producers.'

Most people don't realize that the U.S. is, as Murkowski says in her op-ed, 'the only

advanced nation that generally prohibits oil exports.' Due to decades-old policy, born

in a different energy era, American oil producers are prohibited from exporting crude

oil because it was perceived to be in 'short supply.' (Note: refined petroleum product,

such as gasoline and diesel, can be exported and is our number one export. We are

also about ready to ship our major first tanker full of natural gas headed for Europe.)

Today, when it comes to crude oil, our cup runneth over. The U.S. is now the world's

largest producer or oil and gas. Rather than short supply, we have an over-supply-so

much so that American crude oil (WTI) is sold at a discount over the global market

(Brent). This disadvantages U.S. producers but doesn't benefit consumers because

gasoline is sold based on the higher-priced Brent.

Murkowski argues that it is time to lift the 40-year-old oil export ban. She's

introduced bipartisan legislation that would do just that, but, if he was so inclined,

President Obama could reverse the policy himself-if he found it to be in the national

interest. And how could it not be?

Allowing U.S. crude oil into the world market enhances global energy security, as it

would be less impacted by tensions in the Middle East. Our allies in Europe and Asia

would have access to supply from a friendly and reliable source-remember the Arab

Oil Embargocrippled Japan's economy because it had no domestic supply and was

overly reliant on Arab sources. Lifting the oil export ban would allow U.S. crude to be

sold at the true market price, not the discounted rate, which would help stem the job

53

losses currently being felt throughout the oil patch due to the low price of oil and

exacerbated by the drop in the price of crude triggered by the Iran deal.

So, the Obama Administration is lobbying Congress to lift the sanctions on Iran, a

country that views America as The Great Satan. Lifting sanctions would allow Iran to

resume full oil export capabilities and boost its economy-while refusing to give our

allies and our own country the same benefit. Iranian oil will enter the world market,

while Canadian and American oil is constrained. How is that in the 'national interest?'

It appears we might just be living in a country founded by geniuses and run by idiots.


Energy Makes America Great

Documents

OilVoice Magazine - August 2015