Its normally a waste of time to read an annual report released six months after year end, however that isn’t case for Saudi Aramco’s 2016 Annual Review [LINK] last week. There was good food for thought on long term oil markets that was overlooked in the headline reporting of 260.8 billion barrels of oil reserves and record oil production of 10.5 million b/d. It may not impact 2018 and the detail was lacking, but Saudi Aramco noted positive indications on three key technology initiatives that can impact long term (ie. post 2025, perhaps sooner) oil markets – solar efficiency losses from dust, increasing recovery factor from waterfloods using SmartWater, and fracking without sources of fresh water. If they can get the economics to work, these can impact long term oil markets by either potentially reducing Saudi Arabia demand for oil used for electricity generation or increasing oil recovery factors/lowering Saudi Arabia decline rates. What caught our attention was Saudi Aramco saying they are making progress on each and we can see them wanting to advance these technical initiatives to help with the marketing ahead of their 2018 IPO. Their ability to make these technology advancements work, or not work, economically could have a big impact on long term oil markets.
Can “SmartWater Flood” arrest declines in some of the older oil pools? In 2005, peak oil was a key oil market theme driven by fears of increasing declines on ageing supergiant and giant oil fields around the world ie. Saudi Arabia’s super giant Ghawar oil field. Other than Ghadar starting production in 1961, information on Ghawar isn’t clear, but believed to have peaked at just under 6 million b/d around 1981, slipped below 5 million b/d, returned to over 5 million b/d with the development of southern portions of the field and is still believed to be just over 5 million b/d. In 2005, there was a fresh example of Alaska’s Prudhoe Bay that had peak production of 1.6 million b/d in 1987, went below 1.0 million b/d in 1994, and in the height of peak oil fears was down to 0.3 million b/d in 2004. The peak oil people were pushed to the sidelines as increasing oil prices drove oil capex up everywhere, supply responded from the high capex and also from technology improvements unlocking deepwater, heavy oil and ultimately shale led to increasing oil production. But the basis to the peak oil thesis isn’t wrong. Declines are a fact for oil fields, and as oil fields age, declines ultimately accelerate – it’s a question at what rate and when. There will be an increasing challenge to moderate declines in aging large oil pools in the Middle East and China, which is a key reason why we remain bullish on mid term oil prices. And there have been subsequent examples of peak oil pools since 2005. Mexico’s Cantarell oil complex reached peak oil production of 2.2 million b/d in Dec 2003, but is now producing ~0.2 million b/d. Decline rates will always be a question for any ageing oil fields in Saudi Arabia, or elsewhere. A key reason for the peak oil concern in the mid 2000’s was that it was a big black box for any detailed information on Saudi Arabia’s oil fields. Its why we believe the Saudi Aramco IPO is such an important event, it should bring better disclosure of information and insight on Saudi Arabia oil fields. This increased disclosure and subsequent analysis on Saudi’s oil fields may well determine the long-term view of oil prices.
But remembering peak oil is also why we found the most interesting comment in the annual review was the Saudi Aramco progress on using SmartWater. Saudi Arabia waterfloods its oil pools, but has been forced to use seawater. Seawater is not as effective for ultimate oil recovery vs using fresh water. There is very little fresh water in Saudi Arabia. SmartWater is not a new idea, Saudi Aramco has been working on SmartWater for several years. Our non-technical explanation is that its chemistry – Saudi Aramco modifies the salinity and ionic composition but does it without adding any new chemicals. There are many technical papers explaining the difficult part – how SmartWater frees up more oil to be recovered. Saudi Aramco said “Our SmartWater Flood research program continued to show potential to improve oil recovery rates from carbonate reservoirs by an additional 4% to 8%. The results of our in-house research program and single-well field trials have shown that injected seawater, whose ionic composition has been optimized, outperforms traditional seawater injection. In 2016, we completed detailed engineering design for the main surface facilities for a multi-well demonstration project at ‘Uthmaniyah, and advanced the design of another demonstration project at Khurais.” It sounds like this continues to move ahead, and it could help reduce future decline rates and recover more oil ie. allow Saudi Arabia to maintain oil production for longer. It isn’t clear if the SmartWater can help all the Saudi oil fields, especially Ghawar. But we should get a much better picture in the runup to the IPO. This could be a significant development that could help them avoid a Cantarell massive decline rate that crippled Mexico’s oil industry. Of course, the question will be at what cost? There is no question that Saudi Arabia operating costs will increase, but we have to believe they will pay that price to mitigate declines.
Can Saudi Aramco eliminate or significantly reduce solar efficiency losses from dust? In Jan 2014, a Shell engineer involved in their future energy technologies initiative asked me “what do you think happens to the value of oil if Saudi Arabia were to stop using 400,000 b/d of oil for electricity after 2025?” He elaborated and said it wouldn’t all happen by 2025 but that it would take until 2030. He explained there was two parts to the solution of how to accomplish this goal. First, solar and battery technology in general had to get to the point that it can compete without subsidies and be reliable enough to provide base generation. Second, Saudi Arabia, despite being sunny, still had to solve its own unique challenges for solar and battery ie. sand/dust. He then shared his view that in 3 to 5 years (ie by Jan 2019), there would be visibility that solar and battery can be an economic, available, reliable alternative for electricity generation post 2025. Its been over three years and we aren’t there yet, but it certainly seems to be pointing to there being, by Jan 2019, visibility that solar and batteries could provide a broader competitive electricity alternative without subsidies in the long term. The baby boomer decision making process seems to have gone, decisions for alternative or clean energy are no longer made on payback periods making sense. So when I say competitive, it doesn’t mean as economic, but within a range close enough to justify the decision.
Saudi Arabia Direct Use Of Crude Oil For Electricity Generation 2009-14 (million b/d)
Source: EIA
Saudi Arabia is in one of the best locations in the world for sun, but also is known for sand and dust storms that can bring a city to a standstill. In the 2016 annual review, Saudi Aramco noted Saudi Aramco’s drive to “become a solar powerhouse”, a goal that accelerated in 2016. Saudi Aramco also noted that dust has a major impact on solar panel efficiency. They noted that “A dust storm can lead to a 40% reduction in efficiency of solar panels, and dust accumulation can lead to an efficiency reduction of 2% per week or more.” The key new disclosure is they have produced a “low cost technology” that “After two years of research and prototype testing, the solution offered by the technology is a robotic, dry cleaning technology that is fully automated to run on schedule or on command. The technology has multiple patents pending and discussions are underway to commercialize the technology and bring the product to market. It sounds promising, but it isn’t clear how close they are to having this incremental “low cost” solution being economic, or will this allow solar panels to be put in most places in Saudi Arabia. Prevailing winds are north to south so we would expect there will likely be parts of Saudi Arabia that will be more efficient for solar (ie. less sand/dust storms). But if Saudi Aramco can solve the particular sand/dust issue for reasonable additional costs, then they could be in a position to reduce oil demand for power generation in the long term.
World Map of Direct Normal Irradiation
Source: Solargis
Can Saudi Aramco find a way to ramp up shale without using fresh water? Saudi Arabia’s shortage of fresh water also limits their ability to crank up fracking. If they are successful in fracking without fresh water, this could be something that could have application in other parts of the world. We are seeing how US shale leaders, like Pioneer, are investing significant capital to ensure they have water for their Permian fracking. The lack of fresh water is viewed as a key limiting factor for the ability of Mexico to ramp up shale activity south of Texas. Saudi Aramco noted “Other highlights of our research programs include: • High-temperature fracturing fluid system using untreated seawater and designed to conserve freshwater and treated seawater. A field trial is scheduled for 2017. • Waterless fracturing fluids based on CO2. This technology uses supercritical CO2 (carbon dioxide in a fluid state) to keep hydraulic fractures open. We synthesized nearly 100 polymers and co-polymers and expect to test them under supercritical CO2 conditions in 2017.” The impact on long term oil would be the ability for Saudi Aramco to ramp up shale gas drilling for increased feedstock and for natural gas for electricity generation ie. another way to reduce using oil for electricity generation. One of the other Saudi Aramco priorities is to expand their Master Gas System within Saudi Arabia.
Saudi Arabia is going to be in the news for the next year in the run up to the Saudi Aramco IPO in 2018. On one side, they will be looked at as the country with the most to lose if oil prices weaken and therefore be expected to play the lead role in maintaining or perhaps broadening the cuts if it looks like oil will stuck around $45. On the other side, they will need to position Saudi Aramco as a premium brand supermajor with a bright future. Its why we looked at their 2016 annual review to see what potential upsides could emerge for the IPO marketing, and could these potential upsides impact more than Saudi Aramco. The most significant long term upside for Saudi Aramco will be if SmartWater flooding can work at reasonable additional operating cost and can be applied to the big Saudi oil fields. It would be a big plus to the long term view of Saudi Aramco and reduce concerns declines could hit quickly at some point in the future. It sounds like its working, but expanding SmartWater floods will take years to broadly implement. On the flip side, if these technology initiatives don’t end up working, it could be a big plus to mid and long term oil prices.