Editor’s note: 

The topic of peak oil is increasingly visible in the mainstream media. Jim Puplava and Dr. Duarte are certainly at the forefront of the discussion for several years.

In this analysis, Dr. Duarte reports on a proposed accounting change to proven reserves by major oil companies, and the repercussions if such changes are put in place.

More specifically, despite persistently high oil prices, the stocks of major oil companies, such as Exxon Mobil are increasingly weak, while the stocks of some alternative energy companies, such as those featured in the Wilderhill Clean Energy Index (ECO), are showing some relative strength. See below for charts. Listen to the February 11, 2006 broadcast of The Financial Sense News Hour for more details.

In other words, we could be seeing the early stages of a boom in alternative energy, coupled with at least a temporary weakness in the major oil companies.

The article appeared originally at www.joe-duarte.com, on February 7, 2006. It was updated on February 11, 2006, exclusively for FinancialSense.com by Dr. Duarte.

For more details on alternative energy, see “Ethanol Hits The Big Time,” by Dr. Duarte (http://www.financialsense.com/editorials/duarte/2006/0131.html).

Also, see “Peak Oil: On The Verge Of Hitting Prime Time,” by Dr. Duarte
(http://www.financialsense.com/editorials/duarte/2006/0120.html).

Today's Analysis
Peak Oil: Big Guns Want Reserve Accounting Change

Oil companies want to change reserve accounting rules raising questions about the timing with regards to peak oil. The move might be a hint of more trouble yet to come with regards to how much oil is actually left in the reserve column for the major oil companies.

According to the Wall Street Journal big oil companies have issued a report with the goal of justifying how they account for their own strategic reserves.

The companies think that they can "be the best judge of their own stores of oil and gas rather than use a strict formula imposed by the Securities and Exchange Commission. The companies argue that the SEC's method -- intended to provide investors with apples-to-apples comparisons -- is archaic and arbitrary, and undercounts the amount of energy on tap for the future."

The key to the whole situation is how fast a company replaces the oil it pulls out of the ground, a key measure used by Wall Street to give the company's stock their trading value.

The issue is complex, as "securities analysts don't necessarily agree with the SEC's conservative guidance on how to account for oil and gas in the ground, but they also tend to doubt the companies' optimistic forecasts of their stores."

Some in the business, such as "Matthew Simmons (ed. Note: Author of "Twilight In The Desert”), a Houston-based energy investment banker and among a crowd of forecasters who believe the world is running short on oil, says the SEC rules should be even stricter."

Under the current system, one thing is certain, "there's no definitive way to predict how much oil or gas lies in any given field -- even industry insiders have described such estimates as being more art than science. While companies would like to show off the best possible numbers, the SEC favors a more-conservative approach to protect investors from placing their bets on inflated numbers that could prove wrong.'

The Journal provides the following example: " Exxon Mobil Corp., the world's biggest oil company, last year said that its own calculations showed it had succeeded in adding 1.8 billion "oil-equivalent" barrels to replace the 1.6 billion barrels it had pumped in 2004. In other words, by Exxon's calculation, it had replaced more than 112% of the oil and gas it had pumped out of the ground the year before. But using the SEC rules, the oil giant actually fell behind, replacing only 1.3 billion barrels, or 83%."

A quick look at the numbers shows that Exxon's numbers are 30% above the SEC's. Even if you split the difference, Exxon would only have replaced some 97-98% of the fossil fuels it had extracted, falling slightly short of breaking even.

If you took that same formula and plotted it out over twenty years, you could see that 20% or so of the oil is not being replaced. Even if you cut that number in half, you still come up short.

To be sure, our quick and dirty back of the napkin calculations are purely speculative. But, if you're right on the trend, it's not hard to see why oil companies would want to use a less conservative formula to calculate their reserves.

In other words, this is likely to be a hugely controversial issue for some time, as "the stakes over whose tally is right are high."

The Journal summarizes the scenario well, noting: "Oil production is dropping in the U.S., and about three-quarters of known global reserves are controlled by foreign governments and thus mostly off-limits to Western oil companies. Also, many new projects are in politically unstable regions, or in areas where it is difficult and expensive to drill, such as ultradeep waters off Africa and the Gulf of Mexico. Longer exploration and production schedules involved in getting that oil also set the bar higher in meeting SEC standards for claiming reserves."

The report's authors, Cambridge Research And Associates (CERA), hosts of a prestigious conference that starts today in Houston "proposes that the industry itself should decide how to measure its reserves, with the SEC relegated only to an enforcement role. CERA's 43-page report calls for the SEC to adopt more liberal standards set by the Society of Petroleum Engineers, an industry association."

CERA's report, according to the Journal cites key constraints placed on oil companies by the SEC, such as the rules that "prevent companies from claiming hundreds of millions of barrels of crude oil that can be taken from Canada's oil sands -- oil that is notoriously difficult and expensive to extract. But critics say the SEC rules don't take into account new technology that makes producing the oil profitable. Companies also complain about a rule that requires them to use the market price of oil and natural gas as of Dec. 31 each year to calculate which projects are economically feasible, a criterion for claiming reserves. At higher prices, more oil is profitable to pump. But a Dec. 31 price can be considerably higher or lower than the average for the whole year, the measure CERA prefers."

Conclusion

This isn't likely to go away, as oil companies are increasingly under pressure to deliver profits, while assuring the public that there is still plenty of oil to be had.

The truth is somewhere in between. Our own view remains unchanged. There is probably more oil left in the ground than anyone really knows.

The problem remains one of how to get it, and how much money will need to be spent to get it.

It always comes down to the same thing. Why spend $100 to get something, if you can only get someone to pay $80 for it once you got it?

In other words, there are two ways of reaching peak oil.

1. We really are running out of oil.

2. The oil that's out there, possibly in plentiful quantities, isn't worth getting.

The outcome is the same. Either way, you just don't get it, until prices are high enough to warrant the risk.

Apparently, $70 per barrel isn't a high enough price.

The upshot seems to be that investors are starting to back away from major oil companies after a significant multi year bull market.

From an investor’s point of view, a quick look at two charts, the Wilderhill Clean Energy Index (ECO), and the Amex Oil Index (XOI), show that money is making a move away from traditional oil stocks and into alternative energy.

The Wilderhill Clean Energy Index is near its recent highs, while the Amex Oil Index, below, is starting to fade after a multi year bull market. This suggests that money is flowing away from oil stocks into alternative energy.

A picture is often worth a million words. 

© 2006 Joe Duarte, M.D.
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