Radical Noesis - Thinking outside the box

U.S. crude oil production, which declined following the oil price collapse of late 1985/early 1986, leveled off in the mid-1990s, and began falling again following the sharp decline in oil prices of late 1997/early 1998. During 2004, the United States produced around 7.6 million barrels per day (bbl/d) of oil, of which 5.4 million bbl/d was crude oil, 1.8 million bbl/d was natural gas liquids and 0.4 million bbl/d was other liquids. This compares to the 10.6 million bbl/d averaged during 1985. U.S. crude oil production, which averaged 5.4 million bbl/d during the first eight months of 2005, is now at 50-year lows.

The United States contains over 500,000 producing oil wells, the vast majority of which are considered "marginal" or "stripper" wells, generally producing only a few barrels per day of oil. During 2004, top oil producing areas included the Gulf of Mexico (1.5 million bbl/d), Texas onshore (1.1 million bbl/d), Alaska's North Slope (886,000 bbl/d), California (656,000 bbl/d), Louisiana onshore (228,000 bbl/d), New Mexico (176,000 bbl/d), Oklahoma (171,000 bbl/d), and Wyoming (141,000 bbl/d).

EIA expects that lower-48 States oil production in 2005 will decline by 340,000 bbl/d from 2004 levels, to 4.17 million bbl/d. For 2006, an increase of 400,000 bbl/d is expected. Much of the 2005 reduction and 2006 rebound is due to the disruption and subsequent recovery of production in the Gulf of Mexico.

Generally speaking, Lower-48 onshore production, particularly in Texas, has been falling in recent years, while offshore (mainly Gulf of Mexico) production has been rising. For 2005, prior to Hurricanes Katrina and Rita in August and September, Gulf of Mexico oil production had been expected to increase as new fields came online in late 2003 and 2004 (e.g., the southern Green Canyon deepwater area). By late 2005, the Mars, Mad Dog, Ursa, Thunder Horse and Nakika Federal Offshore fields had been expected to account for about 12 percent of Lower-48 oil production. Now, with the impacts of Hurricanes Katrina and Rita, this outlook has been thrown into question.

As of November 10, 2005, 46.7 percent of the Gulf of Mexico's 1.5 million bbl/d crude oil production capacity remained offline, with 39.8 percent of the area's 10 billion cubic feet per day (Bcf/d) of natural gas production capacity also down. EIA currently expects about 23 percent of the Gulf's crude oil production and 21 percent of its natural gas output to remain shut down through March 2006. Overall, through November 14, Hurricanes Katrina and Rita had caused a loss of nearly 86 million barrels of U.S. crude oil output, and over 440 Bcf of natural gas output. In addition, around 804,000 on bbl/d of crude refining capacity remained offline as of November 9.

The destructive 2005 hurricane season came as the Gulf of Mexico had just about fully recovered from Hurricane Ivan in late September 2004. That storm had also caused significant disruptions to Gulf of Mexico operations, with 102 pipelines affected and 27 platforms either destroyed or badly damaged. According to an assessment by the U.S Department of Interior's Minerals Management Service (MMS), "Of the 4,000 structures and 33,000 miles of pipelines in the gulf....150 platforms and 10,000 miles of pipelines were in the direct path of Hurricane Ivan"

Meanwhile, Alaskan oil production is expected to decrease by 30,000 bbl/d in 2005 and by 20,000 bbl/d in 2006, to 860,000 bbl/d. This continues a steady decline since the state's peak output of 2.02 million bbl/d in 1988. For the period January-August 2005, Alaska averaged production of about 872,000 bbl/d of oil, or about 16 percent of total U.S. crude oil production. Over 400,000 bbl/d of Alaska's oil output comes from the giant Prudhoe Bay Field (major producers include BP, ExxonMobil, and ConocoPhillips), and is transported via the 800-mile Alyeska (Trans-Alaska) pipeline. An oilfield known as Alpine, owned 78 percent by ConocoPhillips and 22 percent by Anadarko, began production in November 2000. Alpine represents one of the largest North American onshore oil discoveries in years, producing around 63,000 bbl/d of high quality, light crude oil in 2004. Production at Alpine is to be maintained using tie-ins to the Nanuq and Fiord satellite fields beginning in late 2006. ConocoPhillips has been the largest oil producer in Alaska since acquiring Arco's Alaska fields in early 2000. The combined crude oil production rate from ConocoPhillips' Greater Kuparak and Western North Slope areas averaged about 156,000 bbl/d in 2004. ConocoPhillips also produced about 142,000 bbl/d at Prudhoe Bay.

In March 2004, the Energy Information Administration (EIA), in response to a Congressional request, issued an analysis of potential oil reserves and production from the Arctic National Wildlife Refuge (ANWR). The report projected that for the mean resource case (10.4 billion barrels technically recoverable, according to the U.S Geological Survey), ANWR peak production rates could range from 0.6 to 1.6 million bbl/d, with initial ANWR production possibly beginning around 2013, and peak production possible around 2024.

In recent years, production from deepwater areas of the Gulf of Mexico has been increasing rapidly, with deepwater wells now accounting for about two-thirds of total U.S. Gulf output. Large fields include ExxonMobil's $1.1 billion Hoover-Diana development (which started up in May 2000 and was producing 80,000 bbl/d by 2002), plus: 1) BP's $2.5 billion Atlantis project, scheduled to come online in the third quarter of 2006, with 150,000 bbl/d of peak oil production capacity; 2) BP's 1-billion-barrel Thunder Horse (previously "Crazy Horse") field, the largest single field ever discovered in the Gulf of Mexico, which came online in January 2005, with peak oil output of 250,000 bbl/d expected; 3) Crosby (developed by Shell, came online in late 2001, peak output of 60,000 bbl/d); 4) Holstein (BP; online in 2004); 5) King (BP); 6) King's Peak (BP); 7) Mad Dog (BHP Billiton; online in early 2005); 8) Marlin (BP); and 9) Nakika (Shell and BP; first production in December 2003; ramping up to 110,000 bbl/d) fields. For its part, BP has stated that it plans to accelerate its deepwater Gulf of Mexico production plans, including the planned $1 billion "Mardi Gras" deep-sea pipeline system, designed to transport more than 1 million bbl/d of oil.

In June 2003, Unocal announced its intentions to build a $500 million deepwater crude oil port, the Bulk Oil Offshore Transfer System (BOOTS) in the Gulf of Mexico 100 miles south of Beaumont, TX. The BOOTS system would have a capacity of 1.2 million bbl/d, and would be linked to refineries in Houston/Texas City, Beaumont/Port Arthur, and Lake Charles. As of October 2004, however, Unocal had placed BOOTS development on hold "pending receipt of sufficient volume commitments from crude oil import shippers."

According to Baker Hughes Inc., which has tallied weekly U.S. drilling activity since 1940, domestic oil and natural gas drilling rebounded sharply from the low point of 488 reached in late April 1999, following the oil price collapse of late 1997. In mid-2001, for instance, the U.S. weekly "rig count" approached the 1,300 mark. After that, the U.S. "rig count" fell, reaching 843 as of mid-October 2002, before rising once again, reaching 1,479 during the week ending November 11, 2005. As of November 11, natural gas rigs outnumbered oil rigs in the United States more than five-fold (1,232 to 241).

Historically, U.S. drilling activity peaked in 1981, with a total of 91,553 wells (43,598 oil, 20,166 natural gas, 27,789 dry wells) drilled in that year. For 2004, a total of 33,813 wells (22,673 natural gas wells, 7,167 oil wells, and 3,973 dry wells) were drilled in the United States, up from the low point of 18,465 total wells drilled in 1999, and also up sharply from the 25,744 wells drilled in 2002. During January-September 2005, total U.S. oil and natural gas wells drilled were up 21 percent from the same period in 2004.

Petroleum Imports/Exports
With U.S. oil production declining and demand increasing, U.S. net oil imports are climbing steadily.

EIA forecasts that the United States will have total net oil imports (crude and products) of 12.2 million bbl/d during 2005, representing around 58 percent of total U.S. oil demand. Overall, the top suppliers of crude oil to the United States during January-August 2005 were Canada (1.6 million bbl/d), Mexico (1.6 million bbl/d), Saudi Arabia (1.5 million bbl/d), Venezuela (1.3 million bbl/d), and Nigeria (1.0 million bbl/d).

Refining/Downstream
No new oil refineries have been built in the United States in 30 years, although existing refineries have increased capacity. In September and October 2005, Hurricanes Katrina and Rita knocked out refining capacity throughout the Gulf Coast region.

The United States experienced a steep decline in refining capacity between 1981 and the mid-1990s. Between 1981 and 1989, the number of U.S. refineries fell from 324 to 204, representing a loss of 3 million bbl/d in operable capacity (from 18.6 million bbl/d to 15.7 million bbl/d), while refining capacity utilization increased from 69 percent to 87 percent. Much of the decline in U.S. refining capacity resulted from the 1981 deregulation (elimination of price controls and allocations), which effectively removed the major prop from underneath many marginally profitable, often smaller, refineries.

Refinery closures have continued since 1989, bringing the total number of operable U.S. refineries to 148 as of January 1, 2005. In general, refineries that have closed were relatively small and had less favorable economics than other refineries in their market area. Also, in recent years, some smaller, less-economic refineries that needed additional investments for environmental reasons in order to stay in business found closing preferable because they predicted that they could not stay competitive in the long term.

While some refineries have closed, and no new refineries have been built in nearly 30 years, many existing refineries have expanded their capacities. As a result of “capacity creep," whereby existing refineries create additional refining capacity from the same physical structure, capacity per operating refinery increased by 28 percent over the 1990 to 1998 period. Overall, since the mid-1990s, U.S. refinery capacity has increased from 15.0 million bbl/d in 1994 to 17.1 million bbl/d in September 2004. As of November 4, 2005, utilization of operating capacity at U.S. refineries was averaging around 84 percent, down from 91 percent on September 16, 2005 following Hurricanes Katrina and Rita.

Financial Performance, Mergers and Acquisitions
With oil prices in the $60 per barrel range, U.S. oil companies are experiencing strong revenues and profits.

Twenty-five major U.S. energy companies reported overall net income (excluding unusual items) of $26.0 billion on revenues of $295.1 billion during the third quarter of 2005. This level of net income represented a 69 percent increase relative to the third quarter of 2004 (see EIA's "Financial News for Major Energy Companies "). Domestic upstream oil and natural gas production operations accounted for $8.5 billion of net income, with domestic refining and marketing operations earning an additional $7.0 billion. Foreign upstream oil and natural gas production operations accounted for $7.6 billion of net income, while foreign refining and marketing operations accounted for $2.0 billion.

Independent oil and natural gas producers, oil field companies and refiner/marketers reported a sharp increase in net income (up 139 percent) during the second quarter of 2005 compared to the second quarter of 2005 (see EIA’s "Financial News for Independent Energy Companies"). This increase in net income was due primarily to large increases in the prices of natural gas and crude oil, and a rise in gross refining margins of 17 percent year-over-year.

On October 13, 2005, the Wall Street Journal (WSJ) reported that Occidental Petroleum Corporation had agreed to acquire Vintage Petroleum Inc. for about $3.5 billion of cash and stock. Other recent acquisitions reported by the Wall Street Journal include: 1) Valero Energy Corp. agreed to acquire Premcor Inc. for $6.9 billion in cash and stock (reported April 25, 2005); 2) ChevronTexaco Corporation agreed to buy Unocal Corporation for about $16.8 billion of cash and stock (April 5, 2005); and 3) Marathon Oil agreed to acquire from Ashland Corporation the 38 percent of the Marathon Ashland Petroleum refining/marketing joint venture that it did not already own (March 19, 2004). Marathon reportedly paid about $3 billion (about $1.1 billion of cash and stock and the assumption of about $1.9 billion in debt) for Ashland's share in the refining/marketing joint venture. In addition to acquiring full ownership of the Marathon Ashland Petroleum assets, Marathon also acquired 61 Valvoline Instant Oil Change outlets and other related assets currently owned by Ashland.

Consumption
The United States consumed an average of about 20.6 million bbl/d of oil during the first nine months of 2005, the same amount year-over-year as in 2004. Of this, motor gasoline consumption was 9.1 million bbl/d (or 44 percent of the total), distillate fuel oil consumption was 4.1 million bbl/d (20 percent), jet fuel consumption was 1.6 million bbl/d (8 percent), and residual fuel oil consumption was 0.9 million bbl/d (4 percent). For 2005 as a whole, EIA’s Short-Term Energy Outlook projects that U.S. petroleum demand will decline by 16,000 bbl/d, to an average 20.6 million bbl/d, in response to the combined effects of the hurricanes and high crude oil and product prices. EIA expects motor gasoline, jet fuel, and residual demand all to remain about flat -- at 9.1 million bbl/d, 1.6 million bbl/d, and 0.9 million bbl/d, respectively. EIA expects distillate demand in 2005 to grow by about 1%, to 4.1 million bbl/d. Finally, EIA forecasts demand for "other oils" (natural gas liquids, liquefied refinery gas, other liquids, etc.) to decline by over 4%, to 4.9 million bbl/d, in 2005.

Petroleum Prices
Average retail regular gasoline prices increased sharply after Hurricanes Katrina and Rita. EIA’s latest Short-Term Energy Outlook forecasts gasoline prices (self-serve, regular) to average close to $2.38 per gallon for November 2005, down from $2.72 per gallon in October. The average pump price for the third quarter of 2005 is now expected to be about $2.56 per gallon, up $0.67 per gallon from the third quarter of last year. Hurricane recovery should result in further price decreases by the first quarter of 2006. Annual gasoline prices are projected to average $2.29 per gallon in 2005 and $2.43 per gallon in 2006. Should colder weather prevail, retail gasoline prices are projected to be 10-14 cents per gallon higher, on average, during the winter months. The real price of gasoline (in inflation adjusted 2005 dollars) remains below the 1981 peak.

Strategic Petroleum Reserve (SPR)
The U.S. Strategic Petroleum Reserve reached 700 million barrels on August 17, 2005. The Reserve was then used in the aftermath of Hurricane Katrina, with an announced sale of 30 million barrels.

In December 1975, the Energy Policy and Conservation Act (EPCA) was passed, officially establishing the Strategic Petroleum Reserve (SPR) as a reserve of up to 1 billion barrels. To store the reserve oil, the U.S. government acquired several salt caverns along the Gulf of Mexico coastline. The first crude oil was delivered to the SPR in 1977 and stored at the West Hackberry storage site near Lake Charles, LA. Other major storage sites include: Bryan Mound and Big Hill in Texas and Bayou Choctaw in Louisiana. Total storage capacity at the SPR is currently 700 million barrels.

In mid-November 2001, President Bush directed the Department of Energy (DOE) to fill the SPR to its capacity of 700 million barrels to "maximize long-term protection against oil supply disruptions." On August 17, 2005, the SPR reached its goal of 700 million barrels, just two weeks before Hurricane Katrina hit. On August 31, 2005, President George W. Bush authorized the SPR to loan oil to help refineries whose operations had been affected by Hurricane Katrina. In addition, the President announced the sale of 30 million barrels to maintain supplies and calm markets. As of November 14, 2005, the SPR contained around 684 million barrels of oil -- the largest emergency oil stockpile in the world. The SPR has a maximum drawdown capability of 4.3 million bbl/d for 90 days, with oil beginning to arrive in the marketplace 15 days after a presidential decision to initiate a drawdown. The SPR drawdown rate declines to 3.2 million bbl/d from days 91-120, to 2.2 million bbl/d for days 121-150, and to 1.3 million bbl/d for days 151-180. Prior to Hurricane Katrina, other withdrawals from the SPR occurred in 1985, 1990, 1991, 1996-97, and 2004.

Under EPCA, there is no preset "trigger" for withdrawing oil from the SPR. Instead, the President determines that drawdown is required by "a severe energy supply interruption or by obligations of the United States" under the International Energy Agency. EPCA defines a "severe energy supply interruption" as one which: 1) "is, or is likely to be, of significant scope and duration, and of an emergency nature;" 2) "may cause major adverse impact on national safety or the national economy" (including an oil price spike); and 3) "results, or is likely to result, from an interruption in the supply of imported petroleum products, or from sabotage or an act of God." Should the President decide to order an emergency drawdown of the SPR, oil would be distributed mainly by competitive sale to the highest bidder(s). This would be accomplished in a 4-step process, including a "Notice of Sale," receipt of bids, selection of bidders, and finally delivery of oil.

U.S. Energy Sanctions
The U.S. maintains sanctions on Iran, but has lifted nearly all of its sanctions on Libya , opening the door to oil investment there.

Since August 1996, the Iran-Libya Sanctions Act (ILSA) has imposed mandatory and discretionary sanctions on non-U.S. companies that invest more than $20 million annually (lowered in August 1997 from $40 million) in the Iranian oil and natural gas sectors. On August 3, 2001, President Bush signed into law the ILSA Extension Act of 2001. This provided for a 5-year extension of ILSA with amendments that affect certain of the investment provisions. In addition, the United States has maintained various sanctions against Iran since 1979, following the seizure of the U.S. embassy in Tehran on November 4 of that year. In 1995, President Clinton signed two Executive Orders prohibiting U.S. companies and their foreign subsidiaries from conducting business with Iran. Executive Order 12957 specifically banned any "contract for the financing of the development of petroleum resources located in Iran." On March 10, 2005, President Bush extended sanctions for another year, citing Iran's "continued support for terrorism, its efforts to undermine the Middle East peace process and its efforts to acquire weapons of mass destruction."

In April 2004, the United States removed Libya from the ILSA sanctions, following fulfillment of that country's commitments to rid itself of weapons of mass destruction and to renounce terrorism. On September 20, 2004, the President signed an executive order terminating the national emergency (declared in Executive Order 12543 of January 7, 1986), with respect to the policies and actions of the Government of Libya, revoking Executive Order 12544 of January 8, 1986 and Executive Order 12801 of April 15, 1992, all of which imposed sanctions against Libya in response to the national emergency. The new September 2004 executive order also revokes Executive Order 12538 of November 15, 1985, which prohibited the importation into the United States of petroleum products refined in Libya. This lifting of sanctions has opened the door to a potential return of U.S. oil companies to Libya for the first time in nearly 20 years.

Besides Iran, the United States maintains sanctions on two other oil producing nations - Sudan and Syria. For more information on these sanctions, please see EIA's Global Energy Sanctions report.