Wednesday, June 25, 2008

Drill, Drill, Drill -- And....

A long-term reader responded to my diatribe about the huge international move to nuclear power with the words, "drill, drill, drill". I think he has been listening to Larry Kudlow.

The fact of the matter is that the drill, drill, drill phenomenon has reached new heights and will not go a great deal higher. In 2000, there were about 1,100 rotary oil well drills operating. The count early this year, 3,400, an increase of 309% in 8 years! And, these are not the low powered rigs of the 1970's. Some of them complete a well in 8 days! remain on site! to drill again and again! from the same location! A small patch of ground can now be used to cover many square miles as the wells are angled. Should we drill at ANWR, an area smaller than Washington DC will be used to explore and area greater than the size of South Carolina. The caribou will roam in peace. When production starts, the servicing costs are reduced by the fact that 40 or more wells end at one location. In 2000, the USA accounted for 45% of all rotary rigs, approximately 500. This year, the USA has 1,900 rigs operating or 56% of all rotary rigs! The USA has seen an increase of 380% in 8 years. The effort is on in America to find more oil; the score is 380 to 309.

The correct question is not drill, drill, drill but where, where, where? The congress has restricted drilling to the played out or least productive locations. The result: the US proportion of total oil production is going down even while we drill more wells than anybody else. It is only in America where the congress has put massive areas, about 85% of the areas of known reserves, off limits. Thus, we drill fast and hard but to less and less effect. Our oil companies are being forced to spend heavily to drill in largely played out areas. Never-the-less, progress is being made. In 2005, the USA had 130 horizontal rigs working. This year there we have 550 so far. A 423% increase in only 3 years. Sizable new production is the result of horizontal drilling combined with the process of fracturing porous rocks. The process is expensive but the oil companies are doing what they do best, producing oil. The misguided have tried to force the oil companies into other businesses, such as ethanol production. This is like requiring a professional basketball player to teach the game of chess during the off season, some could do it but others know they can't.


The Rigzone web site provides information about offshore drilling. There are currently 176 floating rigs working. These massive drilling ships are leased at an average cost of better than $300,000 per day, 109 million dollars per year, each. The annual cost to lease these 176 ships is about 19 billion dollars. They operate virtually non-stop. Very expensive crews are at work 24/7, 365 days per year. Crew members are given rotations on shore leave. While on site, crews work long hours for week after week. One does not spend $300,000 to lease a rig and then shut it down for holidays. The costs of operating these ships is many times the cost of the leases. A single well in deep waters can cost 100 or even 200 million dollars. Drill, drill, drill, non-stop!

In addition, there are 364 jack-up rigs in operation. These rigs lease for an average of $150,000 per day. They too are operated 24/7. Drill, drill, drill at an additional annual lease cost of 20 billion dollars. Annually, hundreds of billions of dollars are being spent on drilling.

Since there are not enough rigs available, more are being built. The demand for steel (for ship hulls and for casings, etc) has been very high in recent years as the worlds infrastructure has tried to catch up with the new demand. The good news is that we almost have. Even so, Brazil recently leased offshore rigs for as much as $600,000 per day. Brazil has ordered $30 Billion worth of new rigs. Drill, drill, drill. Brazil has discovered what appears to be more than 100 billion barrels of oil. It will be several years before this oil comes on line. The most massive discovery in US Gulf waters, the Thunder Horse Field, was discovered in 1999 and was expected to come on line in 2005. It just recently delivered its first oil. The pipelines from Thunder Horse have been connected to Atlantis and Mad Dog. It is no small trick to build a pipeline on the ocean floor two or three miles deep. On the other hand, a billion barrels of oil is nothing to sneeze at.


One of the biggest oil fields ever discovered produced about 16 billion barrels of oil between 1965 and 2003. During 38 years of production, about 17,000 oil wells were drilled in this field, an average of 440 wells per year, drill, drill, drill. By 2003, it was considered to be a depleted or a dying field. At its peak, about 2.5 million barrels of oil flowed from this field 365 days per year. The flow rate gradually fell to 300,000 barrels per day. This field is in Russia where the scientist believe in the abiotic theory of oil creation. They do not believe that all oil was made from dinosaur bones or from rotted plant material from the age of dinosaurs. They believe, as I do, that oil is being constantly "produced" by microbes, 5 x 10^ 30 of them, the number is right, the estimated number of oil chewing microbes on this earth is 5,000,000,000,000,000,000,000,000,000,000.

The good news is that BP stepped up with 10 billion dollars to purchase a half interest in this field. BP formed a new venture with a Russian company and has since drilled 4,500 new wells (900 per year), drill, drill, drill. These have been horizontal wells. They extend for up to 4 miles. The porous rocks beneath these horizontal wells are fractured, using water under high pressure and sand particles to maintain the cracks. The cracks allow additional oil to seep up, that's what I said, seep up, from the depths below. In the past 5 years, the flow rate has doubled. The extra 300,000 barrels per day works out to a retail price of about $15 Billion per year. BP shareholders deserve the profit because their company put 10 billion dollars plus development cost at risk.


The average person can not seem to wrap his brain around the size and relative values of the energy market. People with considerable "brain power" are easily side tracked. For thousands of years, there has been the dream of abundant power from wind mills and, as kids, we learned how to focus the sun to fry ants. I have no data to support my belief that there have been hundreds of windmills abandoned for every single one that is producing energy today. However, I know that my father once hauled two windmills from North Dakota to North Carolina only to discover that the permits would cost him more than the value produced. We simply do not seem to appreciate the "effort" that went into making coal, oil and gas for us. We have been given great gifts. Perhaps the real problem is that we are too proud to accept the gifts given? Drill, drill, drill.

Jimmy Carter proposed that we wear sweaters in the winter and that we tax the oil companies wind fall profits. Who among you is willing to spend 100 million dollars drilling a hole that may produce zero return? Most of you own a tiny piece of Exxon in a mutual fund such as an S&P Index fund. Exxon is a very profitable company and it produces a massive consumer and a massive producer surplus. Both consumers and shareholders benefit greatly from the efficiency of Exxon.

Theoretically we understand fundamental laws such as gravity, the conservation of energy and supply and demand. In practice, democrats are once again proposing wind fall profits taxes. Jimmy Carter used billions of dollars from his wind fall profits taxes to develop synfuels, have you put any synfuel in your car lately? The fact is that the wind fall profits tax made things worse not better. After all, the laws of economics tell us that if you want to reduce the quantity of a good and to increase its price, tax it. Today, you and I are required to pay high prices for oil so that politicians can waste our money on very expensive wind mills and very expensive corn oil refineries. It costs at least 35% more to make power with windmills but, that is OK, your taxes can be used to cover the operators losses.


The big ships are drilling mostly in foreign waters. America has vast untapped resources. What has basically happened in America has been the political marriage of socialist and environmentalist. The socialist believe in command and control economies and the good intentions of the environmentalist have been subverted. Americans are being forced to breath noxious coal fumes while trillions of cubic feet of clean burning natural gas sits. In Alaska, we actually pump billions of cubic feet of gas, produced in conjunction with oil production, back into the ground because construction of a gas pipeline continues to be blocked.

We breath noxious coal fumes while construction of emission free nuclear power plants are blocked. In the USA last year, 50 or so coal miners died and millions of Americans suffered from respiratory problems while Harry Reid blocked the storage of nuclear waste. US citizens pay billions of dollars to Venezuela each year. Some of our money goes to train terrorist and to buy bombs that are used to blow up innocent men, women and children. Some of our money is used to support FARC while democrats refuse to allow American companies to sell goods to Columbia.

Seventy one nations have signed a new treaty designed to eliminate support for terror while supporting UN supervised consortium to refine nuclear fuel. Signors to the treaty cannot have it both ways. They cannot support terrorist bombs or hide nuclear bombs and participate in this extra cheap fuel. GE has patented a new nuclear fuel production process. Laser beams are used to produce fuel at a fraction of the cost of the old process. It will take years to build the refinement centers but they can be ready by the time new power plants are constructed. The time to start is now.

Drill, drill, drill is not enough. Less than half of our energy consumption is oil. About half of our electricity is fueled by coal. Most of the rest is fueled by natural gas and nuclear power. A small amount is fueled by hydro. A very small amount is fueled by oil. The amount produced by wind power is relatively close to nothing; solar power is also close to a big nothing. Wind power receives average subsidies of more than $23 per megawatt and it still is a relative zero. The HEE HAW routine applies: "Doctor it hurts when I do that." "Then don't do that!" The French get 80% of their electricity from nuclear and they export power. The USA needs to stop shooting itself in the foot with wind fall taxes and $5,000 subsides for cars. We can go from 20% nuclear to 80% nuclear if we choose. If the "super battery", whether a hydrogen cell or not, is developed, then we can convert nuclear power to transportation fuel.

The simple answer to our energy problem is to replace income/payroll taxes with consumption taxes. The laws of economics tell us that the change would result in an increase in our income and a decrease in our consumption. What is not to like about that! A tax on carbon would make dirty coal less attractive. It would make wind mills, solar and nuclear more attractive. A reduction to the income/payroll tax would offset our costs in the short run and pay us a bonus in the long term. The response would be rapid. If we all knew the tax on gas was going up 10 cents per year for the next five years and that our payroll tax would fall by an equal amount, we would all find ways to reduce consumption and thus we would lower our individual tax burdens.

One of the beautiful things about a consumption tax is that foreign oil sheiks would pay a portion of the tax. For example, the laws of economics tell us that a 10% increase in the tax on gasoline would not result in a 10% increase in the total price. The increase would cause a shift in the point where the demand curve crosses the supply curve. The result might be an 8% increase in the total price and about a 12% decrease in the revenues to the oil sheiks. The consumer might save $100 in income/payroll taxes for each $80 increase in consumption taxes.