Matthew Simmons: Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy

* Financial Sense: Matthew Simmons: Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, via Energy Skeptic: Matt Simmons: Twilight in the Desert.

Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy

Matthew Simmons, Financial Sense, 06 August 2005


August 6, 2005 Matthew R. Simmons, President Simmons & Company International

JIM PUPLAVA:  Joining me on the program is Matthew Simmons. He’s Chairman and Chief Executive Officer of Simmons & Company International, a Houston-based investment bank that specializes in the energy industry. Mr. Simmons serves on the boards of Brown-Forman Corporation, The Atlantic Council of The United States, he’s also a member of the National Petroleum Council and The Council of Foreign Relations. He has an MBA from Harvard University. And he’s here to discuss his new book Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.

Matt, I want to start out the discussion from the back of your book in Appendix B. Several years ago you did a study of the world’s major oil fields. What did you find?

MATTHEW SIMMONS:  It was really an incredible exercise of trying to collect the data no one had ever actually thought of doing before, and that’s, what are the top oil fields in the world – field by field. And the background for me doing this is that I’ve participated 2 years in a row in an energy supply workshop, conducted by the energy analysts of the CIA in Washington, where they got about 10 of the best oil experts together, and we’d spend a day doing a discussion of all the key countries, and how much oil capacity they had in place over the course of the coming 3 years. I sat there listening aghast at all of these experts with their laptops that kept looking at their supply models, and it’s how China will be producing 3,217,000 barrels/day this year, and 3,281,000 barrels/day. And I basically said: “how do you all even know that. What are the 3 or 4 top fields in China?” And no one had any answers.

So I decided it would be interesting and educational to see if you could actually put together a list of the top 20 oil fields by name. And I thought somebody must have done this before, and the more I dug the more I realized that no one ever had. So I basically decided – arbitrarily – 100,000 barrels per day [bpd] production was my cutoff of what constituted a giant oil field and all Fall of 2000, I believe this was, I basically took data from various areas and kept trying to hone in on the total list, and I decided once I got it done, I would circulate it widely to the 4 or 5 or 6 hundred people who really ought to know the areas a lot better, and that would flush out the real data. What I came up with was finding that there are about 120 oil fields in the world that still produced over 100,000 bpd, and that they collectively were 49% of the world’s oil supply. What I also found is that the top 14 fields that still produce over 500,000 bpd each, were 20% of the world’s oil supply, and on average they were 53 years old. The next thing I found was that in the Middle East you had basically, somewhere between 3-5 oil fields in each of the major Middle East oil producers that made up about 90% of their supply –  and until I did that I had just assumed the Middle East had hundreds of oil fields – and all these oil fields were old. And then what I found was – because we made it clear that anyone who wanted a copy could get one, but the caveat was that if you have any better information, let me know –  I probably shipped over a thousand of these copies out to people and I had about 5 responses of “here’s a field you missed, here’s a field you misspelled or here’s a field you said it was producing X, and I believe it’s probably producing Y.” Only about 5 responses, out of over a thousand people who got this. What I got from hundreds of people was “this is amazing, I’ve never thought about this before.” And these aren’t just sort of random people, these are people that are all passionate energy analysts. So that gave me the background, when I finally had my only trip I’ve ever taken to Saudi Arabia.  I knew ahead of time that they had these 5 key fields that must still be producing 90% of their oil, and it was that knowledge and data that allowed me to just peer into presentations we were having, so that I came away saying, “you know I really wonder whether in fact we’re sitting on an illusion that Saudi Arabia has all this vast amount of producible oil.” And I also then had an idea of what issues I should start trying to research, and within months I had discovered this phenomenal database of technical papers at the Society of Petroleum Engineers, that I spent all Summer, two years ago in Maine, plowing through, and it was at the end of that exercise that I decided I was going to write a book.

JIM:   It’s incredible, because every energy supply model starts with the assumption that Saudi oil is plentiful. It’s inexpensive to produce and supply can expand to meet demand. I mean, whether you’re looking at the IEA or the USGS, that’s not necessarily the case.

MATT:   Yes. What’s interesting is that we’ve based all of this assumption on no data. I mean, it would be like someone assuming General Electric could basically grow by 30% per annum, and that by 20 years from now they’d have a company that was bigger than the economy of the United States, because they needed to do that to support their stock price, and no one ever saying, “Wait a sec, how could a single company ever grow beyond the economy of the United States.” But this is far more important in the unforeseen consequences: that we’ve effectively built a world economy on the illusion that Middle East oil would last forever at inexpensive cost.

JIM:   You know last year, Matt, the Saudi Oil Minister announced they could expand their oil reserves by 77% to 461 billion barrels. Is that a political statement, because there doesn’t seem to be – from looking at your data in terms of how their reserves were compiled – where do they get that number?

MATT:   They assume it! What’s really astonishing is that I had a suspicion 2 years ago, when I’d finished going through 150 of these technical papers, that I might well have done an exercise no one in the world had ever done before, and that’s piece together these individual study-area problems and put them together until you had basically done a forensic pathology of their oil system. And I wondered whether anyone in Saudi Arabia had ever actually done the same amount of research. And now it turns out, I was apparently the first person in the world to ever actually challenge the assumptions of the unlimited amount of their oil supplies. And it hit a nerve I would never ever have expected because I wasn’t a household name – I think I am today in Saudi Arabia – I was just an investment banker in Houston. It was the same sort of reaction if someone went to the Vatican and said, “I hate to tell you all this, but there really isn’t a God, and there isn’t a Pope.” And out of that came a massive public relations campaign by the senior management of Saudi Aramco, the state oil company, and the Petroleum Ministry that effectively has said, “we can produce 10 million or 12 million or 15 million barrels a day for 50 to 100 years. Our 260 billion barrels of proven reserves, there’s this conservative number we can easily add another 200 billion, and we can still add another 200 billion we have yet to discover”. And I actually think that they believe that, which is far more dangerous than “it’s just a political statement.

JIM:   Now the thesis of your book is Saudi production is very near its peak…

MATT:   I decided that this book was going to be so controversial that I really tried my darnedest to avoid a bunch of very specific conclusions that people could shoot holes in: “how would you know that?” But I’ve had enough time now to reflect on everything I wrote about, and also feedback from lots of technical people that said, “you know what, what you triggered is the memory of what was going on in the 70s”, and etc, etc. I think it’s highly likely that they’ve actually exceeded sustainable peak production already. And I think at the current rates they are producing these old fields, each of the fields risks entering into a rapid production collapse.

JIM:   If this is indeed the case then, by assumption, we have to assume global peak is at hand then.

MATT:   Absolutely. Once it’s clear that Saudi Arabia cannot sustain increases in its production on a sustained basis, then in my opinion, with a certainty of 99.9% the world has actually passed sustainable peak production. Because one of the reasons all of these supply models always have Saudi Arabia producing 25 million bpd by 2025 is that there isn’t another country on earth that has the potential to raise their production more than 1 or 2 million bpd at best.

JIM:   Why is it, do you think, there’s only been 2 groups that have been concerned with this: you have the oil company executives, because they are obviously looking around the globe and they’re not finding major elephants on a yearly basis; and then we’ve had environmentalists who have also been concerned about this. Those have been the main 2 groups, but aside from that, you have a third group, the economists, who basically just say, “as the prices of oil goes up the production goes up to meet it.

MATT:   Yes, and they say it with a passion and a vengeance. What I’ve also found so interesting is that the concept of peak oil which is finally getting some serious traction as a discussion item gets scorned by economists – energy economists. What they hear is the world is running out of oil, they don’t understand the concept of peak oil. And I continue to remind people that the difference between oil supply peaking and running out of oil is as profound as someone saying, “I’m getting a little bit hungry,” and someone saying, “I have about 2 more minutes to live before I starve to death.” And we will never run out of oil, in our lifetime, our children’s lifetime, our grandchildren’s lifetime. But by 2030 we could easily have a world that can only produce 10 or 15 or 20 million barrels per day, and the shortfall from what we thought we were going to produce is only a modest 100 million barrels per day. So this is really a major, major, major global issue.

JIM:   It’s not only a major issue, but if you look at Wall Street, the day you and I are speaking, oil is over $62/barrel and the standard response is – in fact, one of the questions given to one of the analysts this morning is “when is it coming down?”… You gave an analogy in terms of how cheap oil is at $60/barrel, I wonder if you might share that with our listeners?

MATT:   Sure. Because every time I get into a discussion now about the future of oil I always get asked, “well, where will oil prices be?” And my response is, “I don’t have any idea where they’re going to be, other than the fact I think on a secular move, we are still at a very, very cheap level of oil prices.” And that immediately gets a response, “Cheap?! Oil’s at $60 a barrel!” And one of the things I’ve observed is that people don’t really understand what a barrel is. They can kind of conceive what a barrel might look like. But when you put it in terms people can understand, I say “what $60 per barrel is, is 18 cents a pint. And then I get a response, “How did you do that?!

“Well, you divide 60 by 42, to get a gallon of oil, and you divide a gallon by 8 to get a pint of oil, and that just happens to be 18 cents a pint.

And then they say, “ Oh, that’s really cheap, isn’t it?

And obviously it’s cheap. I don’t know what’s the next cheapest liquid we actually sell in any bulk is, that has any value. I suspect there are places around the United States where municipal water costs more than 18 cents a pint. And yet for some reason, we created a society that was built on a belief that oil prices in a normal range were some place in the $15-20 level. It turns out $15/barrel, which is the average price of oil – in 2004 dollars –  it sold for, for the last 140 years, is less than 4 cents a pint. So we’ve basically used up the vast majority of the world’s high flow rate, high quality sweet oil at prices that were effectively so cheap, you basically couldn’t sustain an industry. And now we’re left with lots of oil. But it’s heavy, gunky, dirty, sour, contaminated with various things oil, it doesn’t come out of the ground very fast, is very energy intensive to get out of the ground and we’re going to pay a fortune for it.

JIM:   Why don’t you take us back, as we talk about this peak in oil in Saudi Arabia, to when oil was first discovered. Give us a little bit of background about Saudi Arabia, because up until 1930 there really wasn’t an issue in Saudi Arabia. How did they emerge as a global energy power?

MATT:   First of all, just a real quick history of oil because I think it’s actually interesting to put into present context.

A year before the Civil War, Col. Drake effectively was the ‘Thomas Edison’ of discovering oil in Western Pennsylvania. But the oil fields there were tiny oil fields, and the stuff didn’t come out of the ground very fast, but it was fabulously high quality. You know, Quaker State motor gasoline oil quality. So simple refining processes could make it usable. And over the course of the next 40 years oil was effectively a substitute for kerosene and coal gas as a way to create lamp oil. And then in 1901, we discovered the great Spindletop field in Beaumont, Texas, and that was the world’s first giant oil field that could produce vast amounts of oil; and after that and a few years later we discovered the Golden Alley in Mexico; we discovered oil in Iran. And by 1930 we had a concept – we had just discovered the great oil field in Kirkuk, in Iraq, ironically about 2700 yards from the burning oil fires that were mentioned in the Bible, in the time of Nebuchadnezzar – and in 1934 Abdul Azziz, who had just finally consolidated the kingdom that became known in 32 as Saudi Arabia, who’s the father of King Fahd who was buried yesterday, granted a concession to Standard Oil Company of California to begin looking for oil in Saudi Arabia. And in 1938, when the world economy was so fragile that we were still closing banks, they were just about to shut down their efforts  after a very disappointing series of dry holes, when they hit discovery of Prosperity Well #7, and ushered in the oil kingdom of Saudi Arabia. By 1970, Saudi Arabia was producing 3 million bpd; by 1974 they were producing 8 million bpd; by 1980 – because of Iran collapsing and then the Iran-Iraq war – they hit their peak at 10 ½ million bpd and by then they were terrified they were producing oil at rates that couldn’t be sustained, and were going to destroy these great fields, because it was coming from 4-5 fields. And yesterday was not just the day we buried King Fahd. Yesterday was also, ironically, the 15th anniversary of when Saddam Hussein invaded Kuwait.

And it was that event that actually started to profoundly change the world, because within a week of that invasion – and the Republican Guard poised on the Saudi Arabian border to hit the South and to do the same thing to Saudi Arabia they’d just done to Kuwait – President Bush and his chief advisors decided to embargo Iraq and Kuwait, and they convinced King Fahd to station troops in Saudi Arabia to prevent the Republican Guard from taking over Saudi Arabia. Because had that happened, by the end of August, 15 years ago, Saddam Hussein would have controlled 15 million barrels of oil per day and would have been the emperor of the world. So this was really a profound series of changes. And then everyone in the world had to ramp their oil supplies up. And Saudi Arabia took great pride, as they saw, in 90 days, they could go from five back to eight million bpd, and stabilize the world oil markets to keep oil prices from going to $100.

And out of that decision came an accidental move back into a concept that they had no rate-sensitive production, and that is when all of the water problems that were starting to worry them so profoundly in the 70s started coming back. And they’ve effectively spent the last 15 years trying to fight these problems, and figure out how to get out of this box, while they were pretending to each other that their oil fields had no rate-sensitivity of how they were being produced, and what they did for 70 years they could do for another 70 years. So I thought the irony of burying the King yesterday, on the 15th anniversary of Saddam’s move into Kuwait happening at the same time, was really unbelievable.

JIM:   As we take a look at some of the facts as we know them today, the Arabian Peninsula  – as you pointed out in your book – has been very heavily explored, contrary to opinions otherwise.

MATT: Using the very best technology known to man.

JIM:   We’ve got 5 fields that are super giants that account for 90% of the oil. Of these fields, many of them have been in production 50 years or more, and there’s been very few fields discovered since 1980 that produce more than 250-300,000 bpd.

MATT:   In fact, the record actually is, that in 1967 they discovered the last great field that has ever been discovered in Saudi Arabia. And the only field of any significance since then, has been in 1989 the Hawtah field – the Hawtah field and 5 satellite fields – peaked at 200,000 bpd. Now, some of the people that are skeptical of my views say, “how could you say 200,000 bpd isn’t a great oil field?” Well, 200,000 bpd in Saudi Arabia, as the best you’ve done in 35 years, is a very scary number.

JIM:   Why don’t you give us a bit of a history, because I don’t think most people realize we may be driving around here in Southern California with a gallon of gasoline in our tank that came from one of these fields.

MATT:   Of the 10-11 million bpd that we import into the United States, 1.5 of that is Saudi Arabian oil, so statistically there is probably a pretty good likelihood that 1 out of 10 motorists in California have Saudi Arabian  oil in their tank.

JIM:   Matt, give us a bit of a history, because most people know oil wells don’t last forever, but some of these in Saudi Arabia have been around for 50 years. I like the analogy that you use of the chess board and I wonder if we might start with that analogy, as we get to the Saudi fields.

MATT:   Yes. The French Petroleum Institute did a major study a couple of decades ago, about the distribution of oil fields by basin. And what they found was that what seems to happen with phenomenal regularity is that within about 5-7 years of moving into a new area of prospective hydrocarbon, you tend to find the queen first, which is the second largest field you’re going to find; you then calibrate in on the knowledge of how you found that and within a handful of years you find the king; and then over the next decade, you find there too, the next 8-10 lords. And once you’ve found the royal family, the rest of everything you’ll ever find are basically peons in size.

And if you then say, “how did that work in Saudi Arabia?” In 1940 they basically found Abqaiq which was the best, in reservoir quality and quality of oil, field they’ve ever found, and Abqaiq peaked at about 1.2 million bpd in 1972. And then they had a hiatus during World War II when they really weren’t exploring. So had they not had a hiatus, they would probably have fast-forwarded this 4 years. In 1948 they discovered Ghawar which is the world’s largest oil field. In 1951, Ghawar came on production. In 1951 they discovered Safaniya which is basically the largest offshore oil field ever, and in terms of output was bigger than Abqaiq, but basically 40% of Ghawar. And then over the course of the next 15 years they found the rest of the royal family. And from 1967-2005 they’ve actually found an accumulation of little deposits they’ve never produced, even though they were always worried about too little diversification of supply. But for some reason or other they just couldn’t produce these fields. Now they’re going back and trying to rehabilitate a bunch of fields that were crummy fields in the 60s and 70s, that couldn’t ever sustain much production, and they’re claiming these fields can easily get up to 500,000 bpd and last 30-50 years. There is no technical support that that can be possible. You can’t say it’s impossible, but the fact that these fields couldn’t produce in the 70s gives rise to real caution that basically they’re deluding themselves that through the use of modern oil field technology they will be able to do something no one in the world has been able to do.

JIM:   In the history of Saudi oil exploration there’s certainly been a great effort, they’ve used great technologies – state-of-the-art technologies – but simply the oil hasn’t been there to the extent they were discovering it in the 40s, 50s and maybe early 60s.

MATT:   All the great fields, ironically too, were discovered by eyesight, as opposed to seismic.

JIM:   Now, if we take a look at Saudi oil production at 3 million at the time that US oil production peaked in 1971 – you know, Matt, as I look at energy over the centuries we’ve been very lucky as a human race: we’ve had wood as a source of energy; that was replaced by coal; then we had oil that replaced coal and gave us our industrial society –  but more importantly, as US oil production peaked in 1971 Saudi Arabian oil production was able to take off and take our place. There’s nothing out there!

MATT:   With fabulous ease too. Also ironically in the last 3 years of the 1960s, we discovered the last 3 great provinces of brand new oil when we found oil in Alaska in 1967,68; we found oil in Siberia about the same period of time; and we found oil in the North Sea in 1969. And Siberian, Alaskan, and North Sea oil, effectively combined to produce: the North Sea peaked in 1999 at a little over 6 million bpd, it’s already down 25%; Alaskan oil peaked in the 1990s at 2 million bpd it’s now at about 900,000 bpd; Siberian oil peaked at about 9 million bpd and it’s about 5 million bpd. And we haven’t basically found another province since the late 60s.

JIM:   How are we able to keep production up, because if you take a look at the increase in demand now coming from emerging countries such as China and India, oil production has increased for decades? How are we able to do that with many of these fields going into decline?

MATT:   Well, we continue to pull more and more out of the North Sea, and then we found deep water which was a fabulous last shot from the basins we already had shallow water production. And we took the Middle East oil back up to unsustainably high levels of production. So probably, we’re sweeping the cupboard bare. People looked at the way we were able to do this and thought, “wow! this is actually easy,” without realizing what we were actually doing was totally non-sustainable.

JIM:   If I was to use the analogy to advances in technology, were we just using bigger straws in effect to get the oil out?

MATT:   Absolutely. But so many oil experts got giddy, by seeing the return to high flow rates, they started believing that we were actually now finally getting a vastly higher amount more oil out of these fields than we could produce before, and therefore we were headed to an era of unbelievably plentiful oil, at unbelievably low prices. And I’ll tell you, as we speak right now, ironically the same week that Twilight in the Desert began shipping, Cambridge Energy Research Associates, Daniel Yergin, who, I think, a lot of people think is one of the more respected – or maybe most respected – oil analysts on Earth, began producing a report saying effectively – and there was a big editorial piece in the Washington Post this Sunday – that the world, between now and 2010 – which is not very long away – is going to add 16.4 million bpd more oil, and create a massive oil glut, and collapse the price again. Now, I’ve read carefully through Daniel Yergin’s detailed field-by-field bottom-up report, and basically, it is a really flawed piece of analysis in my opinion. But the fact that they obviously believe it’s correct – they’re doing talk shows – shows you the depth of limitation of people that really understand how serious this is. Cambridge Energy Research Associates also, in 2001, were unbelievably pooh-poohing the idea that the United States had now entered a major natural gas crisis. But by 2004 they got the religion. I expect by 2009 they’ll issue a magnificent tome saying, “gosh! it looks like the world is now past sustainable peak oil supply.

But what’s dangerous is how many of the optimists really believe we won’t ever have any oil problems. I hope I’m actually wrong in my dire predictions, but I hope people actually take them seriously and figure out a way to prepare for them, since if we do that we win either way.

JIM:   Let’s talk about this, especially the downside of Saudi oil production which is increased to meet some of the demands in this new century. How is it achieved, and then, I’d like you to address the dangers of over production in terms of what they’re doing today?

MATT:   What Saudi Aramco effectively pioneered in the 60s was a method of injecting water into the flanks of these highly pressurized reservoirs, so that every time you  produced a barrel of water you injected a barrel plus. So you never had reservoir pressure declines. And what they were effectively doing, if you could visualize this on a sort of 3D screen, is that the injected water was basically a giant battering ram, squeezing the oil column up higher and higher, preventing the reservoir pressure from ebbing, and also secondarily, sweeping the oil from the flanks of the field to the center. So the water was basically creating the drive to get the oil out, at very high flow rates, without having to resort to artificial lift. And over the years the amount of water injection has risen to where today – this is again one of those numbers that’s a state secret but you can backend to the fact where, now – to get 8-9 million bpd out of the ground, they’re injecting somewhere between 14 and 18 million barrels of highly salinic water into the oil fields to maintain that rate.

Once the sweep is finished, and they get all of the easily recoverable oil out, the reservoir pressures will collapse just like clockwork – you just don’t know when they’re going to collapse – and once oil pressures collapse, the production of fluids might stay the same, but the vast amounts of fluid will be water as opposed to oil. And then they’ll go into the era of the relentless challenge of pulling oil that is still there out of the ground through artificial lift, just like the United States had to do once we peaked. And the majority of what they will be lifting out of the well bores will be water, not oil. And that statement is just as basic as a doctor saying, “you know, these 70 year old people, twenty years from now, will be a lot older, and most of them will be way, way slower in their physical movements and the quality of life will have diminished, and the cost of life will have risen, but we’ll still have them alive.

JIM:   Talking about the dangers of over production, there was this Senate hearing in 1974 with various Aramco executives, later Seymour Hirsch at the Washington Times talked about the significance of this. I wonder if you might explain the smoking gun?

MATT:   It is a really interesting footnote of history, that almost nobody knows anything about. And I actually had a little bit of understanding, and the book was already at John Wiley & Sons as a finished manuscript, when I finally got the reference points to go back and find that these Senate hearings, and all that’s been in papers, has been residing in the Library of Congress for the last 35 years.

What happened was right at the height of the 73 oil crisis, in early January 74 – when we had gas lines, people were just panicked – Jack Anderson, one of the leading muckrakers of the day published in the Washington Post three back to back articles, saying that he was in possession of secret papers from someone within the Aramco companies, that they had made the conscious decision to convince Saudi Arabia that the fields could be produced at any rate, so that they could get every saleable drop of oil out; and at the rates they were now producing, they had such massive problems that they were going to have to throttle back their oil, and the embargo let them off the hook.

And the Washington Post articles caused enough of a sensation in Washington that the Senate Committee on Foreign Relations, who had a subcommittee they had just recently created, called the Subcommittee on Multinational Corporations and Their Influence on US Foreign Policy, decided to ask Jack Anderson to come in on closed hearings and describe what this was all about. So, on January 28th 1974, the hearings commenced and Jack Anderson asked to be sworn in, and then he begins his hearings by saying, “I want to tell you all that I asked to be sworn in so that everything I tell you is under oath, because Aramco is already saying I am just making this stuff up.” He tells the stunning story about the whistleblowers who have given these papers because they think the Aramco companies are now operating against the best interests of the United States of America. And because he won’t disclose who his sources are  – déjà vu the sort of current reporters’ confidentiality – they decide to go ahead – they being five key senators: Frank Church, Ed Muskie, Stuart Symington, Chuck Percy, and Clifford Case – and subpoena all four of the Aramco companies – this is Exxon, Chevron, Texaco, and Mobil – and out of that come a sheaf of papers and memos, that if you know how to properly analyze this stuff effectively said this was a true story. But because the hearings go on – there are 4 hearings, the last hearings on June 20th, where they have 7 or 8 of the senior executives of the oil companies come in. And only one guy, Bill Messick who’s the chief reservoir engineer at Chevron, who under oath says: “absolutely we were over producing these fields. We could never have sustained these rates. And yes, we were damaging the reservoirs.

The rest all disagree with him, “No, there weren’t any problems. No, this is unbelievable. No, we didn’t worry about getting nationalized.

And what’s amazing when you read through the memos these people were sending to each other, they either didn’t understand what they were writing, or they were fibbing to the United States Senate. Then, in 1979, an event happened. And this is where it gets into more hearsay, because of the fact that the only documentation out of the 1979 subpoenas is a very odd staff report from the same Senate subcommittee, that’s 33 pages long, that effectively documents that Aramco has just lowered their production targets from what used to be 20-25 million bpd, then it was 16 million bpd, then it was 12 million bpd, because they’ve lopped off 70 billion barrels of proven reserves as unrealistic. They said, “if we produce 9.8 million bpd for the next decade and a half, in the early 90s, North Ghawar, Abqaiq and Berri, the finest oil Saudi Arabia has ever produced, it’s 75% of the oil production, will go into irreversible decline.” And what’s interesting is that this 33 page staff report is very garbled. You have to really almost take notes and piece this stuff together. The subpoenaed papers they got from these were basically, for some reason or other, deemed to be so sensitive they were put under lock and seal for a 50 year period of time. And there was a debate about what material to disclose, and so they decided to produce this staff report and dummy it down. Had that gotten the attention it deserved, the world would have known 30 years ago, or 35 years ago, that the Middle East didn’t have unlimited amounts of oil, and we would have had a totally different long term energy plan in place today. And instead, we operated for the next three decades under the illusion that was intentionally created in the early 70s, that the Saudi Arabian oil fields would last forever.

JIM:   Speaking of that period of time, you have a different take on the oil crisis in 1974. You believe that the brief oil embargo was not the problem. It was the lack of spare oil capacity while demand was a runaway freight train between, let’s say, 69 and 78, where we went from demand of 45 million bpd to 65 million bpd – that’s a 44% increase.

MATT:   Yes. We ran out of capacity, and when we started creating shortages then motorists in particular hoarded, and that creates a run on the bank – and if you ever have a run on the bank, banks can’t keep money or cash on hand to equal the deposits they hold – and so the shortages begat more shortages, and that’s what created the 73 crisis and the 79 crisis.

JIM:   Isn’t that where we are, in effect, today. Demand has gone up once again, it has increased, even since the beginning of the new century. There aren’t any notable new sources of supply.

MATT:   Let me give you some really interesting déjà vu numbers that I pulled out earlier this morning while I was thinking about the irony of the 15th anniversary of Kuwait’s invasion by Iraq. I had just produced a paper called the Coming Domestic Oil Embargo –  and it got enough notoriety that Forbes magazine was in preparation for doing a major article that came out a week after Saddam’s invasion, called the Coming Domestic Oil Embargo, and they had a fabulous illustration of Uncle Sam filling up his car at a gas station and accidentally stepping on the hose – and what the story was all about was my concern that unless we started a totally different energy policy of using less energy, or a policy of expanding our oil supply through removing the drilling bans in the inner Continental Shelf, and finding a way to jumpstart creating more drilling rigs, and bringing more people back in, we’d wake up some day – and I never thought it would be that day, or anytime in the 90s, but I knew it would take 10 years to make this happen – we would find we had actually embargoed ourselves.

Let me tell you what the numbers were all about, because I had not thought about this until yesterday and today. In 1990 the United States was still producing 7.3 million bpd of crude oil, today it’s 5.1; the 7.3 was after a drop over the previous 5 years of 1.6 million bpd; our refineries only needed to run at 13.5 million bpd; and we only needed to import 5.8 million bpd of crude oil imports to balance our system. Today we have to run our refineries at 100% or we have major product shocks; today, we have to import 10-11 million bpd, or we lose crude oil stocks; we have to basically create almost 3 million bpd of finished product imports; we have to run the system on a 24-7, all Summer long. And we still liquidate stocks.

So we have actually now created a pending domestic embargo, and we’re going to be lucky to get through the Summer without some periodic shortages. We probably will, but the odds are probably as high we will have some shortages, and then if we get through the Summer we have a fabulous respite from Labor Day to Thanksgiving, until we hunker to try to figure out how the world gets through the Winter of 2005 and 2006 because oil demand globally could easily go to 86-88 million bpd during the Winter, and that could easily exceed supply by 2-5 million bpd.

JIM:   If that was to happen we would almost be looking at $75-80 oil, I suspect.

MATT:   No, no, no. Oil prices could easily go up 5-10 times.

JIM:   Wow! Matt, let’s take people on a sort of trip to the past, and I want you to explain Aramco. What was Aramco, how did it start? And then from Aramco becoming the Saudi Aramco, explain how reserves increased substantially without oil discoveries, and they remained there the same.

MATT:   First of all, Aramco used to be called Casco, when it was 100% owned by Chevron, and then they brought in Texaco as a partner, and that’s actually when they changed the name to the Arabian American Oil Company – Aramco – and Texaco came in as a partner as more of a marketing arm, to help them get rid of this Saudi Arabian oil because Saudi Arabia didn’t need any oil. And then after World War II they invited Exxon and Mobil to come in as partners. And so those were the four owners of Aramco, with Saudi Arabia being the host government getting production sharing payments – sort of rents – for this oil. Then in the early 70s the Saudi Arabians took over 25% ownership, even though everyone said, “No, they’ll never take us over.” But by the end of 1979 they had bought out the four owners. And that’s when they kept the name Aramco until, I think, 1988-89. But from 1980 on, Aramco was basically run by the Saudi Arabian petroleum ministry.

In 1979, when these Senate hearings were being held and under subpoena, what the last year Aramco was being managed by the best technicians within Exxon, Texaco, Mobil, they told the Senate investigators that under proven reserve methodologies required by the SEC, Saudi Arabia had 110 billion barrels of proven reserves, but interestingly enough they said 61% of those, say 65 billion barrels, were coming from the 4 fields that created 87% of the production. And the other 39% were the other 13% of production, which raises in my mind how valid the 110 even was. Probably overstated. They said that if you add proven and probable together you get to 177 billion barrels. And if you take proven, probable and possible you get till 246 billion barrels.

By 1987 those same fields’ proven reserves had escalated to 260 billion barrels and they’ve stayed there ever since, and they found only one other significant field. Now, what I found amazing is, there are quite a few people that basically tell me with some conviction that they really believe the 260 billion barrels is a real number – conservative – and they real believe somehow or other, regardless of how much oil Saudi Arabia has produced over that period of time, they’ve found a way to just continue to add because these fields are so big. I happen to think there is very, very good, solid evidence, to say that the guys doing reserve estimation in 1979 were far more knowledgeable about how the art-form is needed to do that analysis, than the new generation of computer jocks who just enter assumptions into a computer and the computer does the thinking for them. So, I would suspect that the real, easily recoverable high quality proven reserves were probably about 70 billion barrels in 1979, and that they’ve now produced 55 billion of those, which gives rise to one more triangulation of the fact that we should be prepared for, and not totally surprised when the five key fields of Saudi Arabia go into irreversible collapse. And they could fall over a 30 month period of time by 50-70%. Hopefully, that’s a draconian estimate but the fact that that has at least a 35-40% probability shows you how unbelievably dangerous it became to have no data and such strong beliefs.

JIM:   One of the things that struck me about reading your book is once the Saudi government took over Aramco they immediately increased the reserves, without any oil discovery to back that. And then in 1988 – I believe this was all done politically – there was another significant increase in reserves so…

MATT:   They jumped from 110 to 160, from 1979-1980, and then at the end of 87, starting with the number they reported in 88, the 160 became 260. They were called paper barrels at the time.

JIM:   And wasn’t that the case with a lot of OPEC countries, that all of a sudden, overnight, everybody increased their reserves.

MATT:   They all got into arguing that they should have production quotas based on the number of proven reserves. And so Kuwait, and Iraq, and the UAE went from 30 billion each to 90 billion, and actually, to give Saudi Arabia credit, they were the last to fall in line of the Middle East producers and also triple their reserves. But why anyone ever  believed it is what I find so amazing. Any time you see a static number for twenty years, people should obviously start saying, “that obviously isn’t a real number.

JIM:   This is surprising too, because what does OPEC produce, anywhere from 22 million to what, 27 or 28 million?

MATT:   If you include all of OPEC today they basically produce somewhere between 27 and 31. And the fact that we don’t actually know that is scary.

JIM:   And yet they’re producing 27-31 million bpd…

MATT:   Of the world’s 85.

JIM:   And their reserves never go down. And nobody questions it?

MATT:   And knowledgeable people! I was on Canadian broadcasting Corporation’s morning radio program yesterday and they quoted a friend of mine that they’d interviewed the day before, Professor Michael Economides of the University of Houston, and Michael said something to the tune of, “I have a high degree of admiration for Matt, but he is totally wrong on his views of Saudi Arabian oil. I’ve done the numbers and the 260 billion barrels is very conservative, and they can easily add another 200 billion barrels, and adding 5 or 6 million bpd for the next 50 years is very easy for them.” And I thought to myself, “How does a person actually say, ‘I’ve done the numbers’, when there are no numbers to do.” But he obviously believes them, otherwise he wouldn’t have been quoted on Canadian Broadcasting Corporation. He’s written a book called the Color of Oil, and he was a Schlumberger technician before he became a Professor at Texas A&M, and then U of H. So you know he’s not a shoeshine guy or a novice, he obviously believes that it’s a conservative number. I don’t have any idea how he comes up with that concept.

JIM:   Well, the same is true, is it not, of Daniel Yergin, where they came up with the same kind of story?

MATT:   The presumption I have is, if you actually ask them the pregnant question, “tell me, within your top 5 clients, does Saudi Aramco happen to be one of them. I think you’d have both of them, if they were telling the truth, say ‘Oh, yes’.

JIM:   Now in your view and study of these oil fields, you believe – and we need to emphasize again that many of these fields have been around 45,50 years producing oil – that a lot of these major fields are close to tipping points.

MATT:   Yes. And I also believe that – Ghawar, for instance, which is really the whole 9 yards, because that is 60% of their production – that North Ghawar, which is the top 20% of the field, has a productivity index that is about 25 times the productivity index of the rest of Ghawar, and that’s the area that is almost depleted now. And when that drops, you could basically see Ghawar go from 5 million down to 2 million bpd in a very short period of time.

JIM:   So, based on your study – and in fact you state this in your book – you believe there is no way that Saudi Arabia is going to be able to produce 20-25 million barrels.

MATT:   No, that’s impossible. What’s interesting is that now there are a number of people within Saudi Arabia that are starting to say publicly, “No, that’s impossible.” Dr. Sadad Al-Husseini who was eased out of being Executive Vice-President of Saudi Aramco a year ago February, because I’m told, he was actually starting to scold people for being naive about how much they could produce, has been on record in several different places as saying that Saudi Arabia could never produce over 12 million bpd. It is just not in the cards. And he was known by everyone who counted as the brains of Saudi Aramco. So we should be listening carefully, and I’m going to be very curious to see in the new regime change whether there’s some jobs that start to change, because I have a sneaking suspicion that my book is going to educate some people in Saudi Arabia to what the real issues were. And maybe some heads were going to roll – not literally – of people that have been promoting this concept of ‘don’t worry about our oil’. And we’re going to go back to a return to the conservationists within Saudi Arabia, and see them lower their rates of production, so they can sustain it for a longer period of time. And if that happens, I think I’ve done Saudi Arabia a great favor because I’ve given them grounds to do that, without the world thinking, “these crazy people in the Middle East are trying to blackmail us.

JIM:   Let me throw something that typically comes out – and maybe this is just a natural phenomenon being an American – is our great belief in technology, Matt, and anytime you talk about oil shortages, or higher oil  prices, the technology factor comes to the forefront and, “Hey, we’ve got all this great technology, we have better technology today than we had a decade ago and this technology is going to save us.” But you don’t believe that’s the case.

MATT:   I know it’s not the case. The one thing our firm is really good at is understanding the oil services industry, that’s the one part of the oil energy investment business we’ve really had a dominant investment banking position. During the 80s, when the industry was under such duress and struggling to survive, we got involved in so many of the rescue projects of these companies, that it really effectively ended up saving the day for horizontal drilling, multilateral well completion, 3D seismic, subsea completion systems, and I know that stuff inside out, as to what it really actually does, because we had to, to get our jobs done. I watched with utter amazement in the decade of the 90s, one oil company after another, starting to go to conferences and say, “the rig of today is like 8 rigs of the past, because it’s new technology. 3D seismic has eliminated the need to drill dry holes. We are now recovering twice as much oil as we used to get out.” These guys are hallucinating. They have no idea what they’re talking about. In 1995-96, I started talking about giving speeches in Aberdeen and Stavanger at the North Sea Oil Show saying, the North Sea is just about to peak and go into irreversible decline and I get these astonished looks by senior executives of the major oil companies saying, “Matt, you don’t understand technology.” Well, it turned out that I didn’t ever say 1999, I said in the next two or three years. 1999 was the high water mark for the North Sea, and it is already down 25%. So it turned out everybody that started using these tools got mesmerized by the high flow rates that got created at the well head, and thinking that they had discovered the fountain of youth. And that’s just what’s going on inside of Saudi Arabia today. They are going through the same hallucinatory process that all our major oil companies did 5 years ago.

JIM:   Based on reading your book, and the extensive studies – as  you said many of these major oil wells are now at tipping points – we’re likely to wake up one day and find out that oil is over $100/barrel, we can’t meet…

Matt: It’s still cheap at $100!

JIM:   Yeah, at $120 it’s 36 cents a pint, which is still cheap.

MATT:   What the economists ought to be trying to figure out is: what constitutes a fair price for oil versus their belief that oil prices are really expensive today. I would argue that probably a number in the $5-10/gallon is a real bargain.

JIM:   Matt, what comes afterwards? One day, as I mentioned, we’re going to wake up and find out that peak oil is here, we’re going to be dealing with it. Do we go to oil rationing? Do we go to a major, national conservation program? And I guess even more importantly than that, given the high demand on oil today – not only just from the United States and Europe, but India and China – how do we ration oil without going to war?

MATT:   We have to figure out a way to do that because if we go to war, it will actually be the worst war we’ve ever fought. And if we don’t address the problem, we will be in an energy war. What I find interesting is I actually think we can solve this problem, but I also think if we ignore it, you can’t create a scenario that is too awful. What we have to do is first of all, long term, create some new forms of energy that don’t exist today. That might or might not be possible. I suspect that actually it will be possible because we haven’t worked on it for a hundred years. While we’re doing that though, we have to figure out a way that allows the world to prosper and not shrivel up while we’re using a lot less oil per capita. And figure this out quickly enough so we educate the China and India’s of the world on how to create a sustainable society so they don’t build a society like ours. Because it’s going to be easier for them to do some of these things than it is for us.

And I’ll give you just a quick shopping-list of some of the things that we are actually going to need to do. In the shipment of goods, we use worldwide about as much, or a little bit more, diesel fuel than we do motor gasoline, and most of the diesel fuel is used by the truck fleets moving goods. If you could wave a magic wand and in a 5 year period of time and get all of the goods off the highway system going long distances by trucks, and put them on either railbeds or water transportation: on the railbeds – railroads – as long as you have long distance transportation, and long trains versus short trains, and short distances, you can get an energy efficiency savings of somewhere between 3 and 10 times – that’s not 3 and 10%, that’s 3 and 10 times; if you can get them on boats versus trains, it has an additional energy efficiency savings of another 2 to 5 times. So by getting trucks off our highway system we have a major impact on removing traffic congestion. And traffic congestion is public enemy number 1 through 5 on passenger car fuel efficiency. So it’s a real win, win, win.

At the same time we have to alter our distribution of food. You know, the average thing we eat today comes from, I believe, an average of 1500-2000 miles. But there are a lot of items, like the first time I ever heard of this concept of food miles was a speaker in London, last Spring, who pointed out that in the Summer in the UK, almost all the apples come from New Zealand, and they have embedded in them 22,000 miles of travel of a vessel, half coming from New Zealand, and the others going back. When they’re onboard the vessel they’re refrigerated. So it’s a very energy intensive process. We actually can grow stuff close to home in most parts of the world. We just got lazy and thought it was really fun to just go into a grocery store and see all this produce: it doesn’t taste very good, but it looks nice.

And then finally we can basically go to distributed work. Because I found being in Maine in the Summer is a lot more pleasant than being in Houston, I taught myself 10 years ago how to be up here and be more efficient than when I’m in Houston. I think there are lots of corporations that have a thousand people working together; there’s no need for a thousand people to be working together, other than the fact it was just a historical coincidence. We now have the technology that people can actually either work at home or work in their village, and by saving 2-4 hours of commuting they will be far more productive. And then we basically end globalization as we know it today, which is effectively a really flawed plan of breaking manufacturing components down into their smallest parts, and finding the cheapest place in the world to manufacture the parts, and then zinging them around the world to be assembled into bigger, and bigger units, until they finally arrive on the showroom as a piece. If you make stuff close to home, you can have a major savings in fuel efficiency. That sort of a plan put in place over 5-7 years would take a lot of coordination; not a single one of those things are impossible to do. We could literally end up cutting oil consumption by 20-40%, by doing all of those. [56:04]

JIM:   You know, the only problem with that, Matt, as we speak right now, with $62 oil, we have, as you say in your book, no plan B.

MATT:   Nope. While we’re doing Plan B by the way, we jumpstart the largest energy R&D program ever envisioned, and just pray that over 5-7 years it has the same impact as when people got serious about developing radar, and developing nuclear power, so that we could actually win World War II. But if we don’t do these things, then this really ends up being a very dark world – no  pun intended.

JIM:   The problem is, even as you and I are speaking today, we still have, you know,  Economides saying there is plenty of oil that Saudi Arabia can produce…

MATT:   Yup, Dan Yergin says we are going to have an oil flood. But you know what, I really love the study of history, I think you can learn so much about history, and on August 3rd 1939, we were down to 28 days left before we officially entered World War II. Basically, Hitler had conquered a whole bunch of places, and yet there was still one loud voice in the world, Winston Churchill, saying, “this is madness!”  99% of the other people that observed were basically saying, “You know, I’m so glad we never ever going to have a war again because war is so awful that we should just never have another war again.” And we got a rude awakening on September 1st 1939, that in fact we were at war. And in a 6 year period of time – 5 ½ year period of time – England, Canada, the United States, Australia and New Zealand built a war machine that was so powerful we destroyed Europe and Japan. And I think if we take this as seriously, when we have a wake-up call, that we can actually end up with not having to basically destroy the world as we know it today before we rebuild it, but doing it before it gets destroyed.

JIM:   What is it going to take to get us to that point? Is it $100 oil, gas lines…

MATT:   A shortage. I hate to say it, but I just think if we are where we are today – where things are so unbelievably crystal clear for me – there was a program in Washington, DC where 5 of us spoke at the Hart Senate Office Building for 2 ½ hours, from 2:30 to 5:00 in the afternoon on peak oil. And of the 5 of us, I was the only one who didn’t have a Phd. And the first one who spoke was Roscoe Bartlett from Maryland, who has his Phd in science, became a Congressman when he was 66 years old, has 40 or 50 patents to his name, and he gave the most impassioned speech I ever heard anyone give on peak oil being the biggest risk the world has ever faced. And you know, this conversation should have happened a decade ago, but thank heavens it’s happening today. But I also think we’re going to have to have a shortage before we realize that this was effectively Poland being invaded by Hitler.

JIM:   Matt, what has been the response to your book – not only in Congress, but also let’s say in the White House – because it’s going to take leadership from the top down to get this country moving in that direction?

MATT:   First of all, I don’t know and I haven’t tried to call people and say, “How did you like the book!” I know from being in Washington twice last week, a lot of people in government are in the middle of reading the book. It’s not a hard book to read, but it’s not a book you sit down in the evening and say I’m going to do this from cover to cover. And so my guess is – what I was told yesterday by the publishing firm, they just did their July wrapup, they are now in their third printing, it has sold 44,500 copies, which is a really tremendous amount of books in their experience for a book that has not had really a ton of publicity yet – I think it will be Labor Day before I start getting really good, widespread feedback. But from the letters and emails I’ve had so far, which range in the hundreds, I’d say 1 out of 20 people are raising questions or suggesting I should’ve done something different, and about the other 19 are saying the nicest compliments I could ever imagine. I would’ve actually thought, getting closer and closer to the publication date, that by about 6 or 8 eight weeks into it, somebody would have launched an attack of some argument I would never have thought of, to really try to discredit the effort. But so far the arguments have been a handful of people who work for Aramco as clients, and all saying the same thing, “technical papers are a stupid way to do analysis because they just deal with problems; investment bankers don’t know how to read technical papers; and they’ve technically proven they don’t have any problems by their ‘trust me’ statements.

JIM:   Matt, if you were to talk to a reader of your book, and have that reader walk away with one important concept, what would that be?

MATT:   That we’ve probably exceeded sustainable peak oil, and read the book and you’ll see why.