David Hughes on Canada's Oil and Natural Gas (transcript)

MediaDavid Hughes on Canada's Oil and Natural Gas - updated with audio

transcribed by Barry Silver

DH: I am Dave Hughes. I work for the Geological Survey of Canada. I have been there for 31 years. I've worked on energy for my entire career, and I've been concerned about the whole global supply issue, and Canadian and North American supply issues, for more than 10 years.

JD: The first thing that I would like to explore is how you got to be talking about this as an employee of the Canadian government, and as a geologist. That gives you two, kind of, unusual credentials.

When did you decide to start speaking up about Peak Oil?

DH: Well, I've been involved in geology all my life. Graduated back in 1972/1975 with an advanced degree. Worked initially in the private sector on energy. And I've been employed by the Geological Survey of Canada for over 30 years. Worked on energy all of that time. I'm a government scientist, but I'm also a public servant. I consider part of my role, basically, as looking at the security of the people that are paying my salary. I do consulting work with private sector energy companies only because of my expertise in Canadian energy resources. Some of those individuals have shared their forecasts of things like Canadian gas supply with me, which has caused me to be very concerned about the long-term energy security and sustainability for the Canadian people that pay my salary. So, that's where I'm coming at it from. I, initially, became concerned about gas 11 years ago. I did an analysis of Canadian gas supplies at that point in time, and saw a time of serious supply shortfalls, which are now playing themselves out at about this time - likely to get worse going forward. Canadian production, essentially, peaked in 2002. It's remained more or less stable since that time, but only through record amounts of drilling. If drilling is cut back for whatever reason - and it looks like it is, because of the slight dip in the price of gas - we can expect some fairly steep declines in Canadian gas supply. Five years ago, I became concerned about the total energy picture, and, at that time, I put together my own analysis based on all the available data of global oil, global gas, North American gas, coal, global coal, North American coal. And peak coal looks like it's occurred in the Lower 48. The U.S. is now an importer of coal. I looked at electricity: electricity security, basically, crucial for any First World country to have a reliable electricity supply; how that electricity is being generated by fuel; the growth in natural gas-fired generation; and the gas supply implications of that on a reliable electricity supply. Also, globally, population growth by country is very important. And in particular, per capita energy consumption increases; what's happened in the past; available forecast of what's likely to happen in the future; total global population; and the implications of non-energy supply such as agricultural soil, food, water, minerals - all of those resources, which are crucial, really, to maintaining our society and civilization going forward.

JD: Why is the situation problematic for Canadian gas?

DH: Really, all you have to do is look at the last 10 years at what's happened. Even take it back 15 years to 1990. In 1990, we had a gas production probably of around 14 Bcf a day, and we had an overall decline rate of about 13%. So, if you didn't drill a well, gas production would drop by 13%. Going forward to 2004, the overall decline rate on a slightly higher production is now 20%. But, even more important, it's the initial productivity of the gas wells. Back in 1996, the average gas well - when it came on production - it came on production at about 600 Mcf per day. The average gas well, today, is around 200 Mcf/day - a little bit better than that.

JD: That's a thousand cubic feet.

DH: Thousand cubic feet. So, we have to drill 2-3 wells to get the initial productivity of a well that was drilled back in 1996. And you can see it in the overall drilling rates. In 1996, we drilled 4,000 successful gas wells. The price of gas spiked in 2001 - we drilled 11,000 gas wells. We've had about a 10% increase in productivity by drilling three times as many wells. 2003: even though we drilled 14,000 wells, gas production fell by about 3%. So, it basically hit a peak in 2001, maintained that plateau till mid-2002, declined 3% in 2003. We're now drilling nearly 16,000 gas wells per year, as of 2005, and production is about what it was back in 2002. Companies are talking about trimming their exploration budgets, which will play out as steeper declines in productivity. The other thing that's happening is coal bed methane. Particularly in Central Alberta, it's making up a larger and larger proportion of supply for very low productivity wells - 100 Mcf/day instead of, probably, a little over 250 Mcf/day for an average conventional well. So, we have to drill 2-3 coal bed methane wells to equal one existing conventional well. So, the writing's on the wall. We have to drill more and more wells each year - hopefully to stay flat - but, eventually, even to hold declines, to relatively small, incremental levels.

JD: How do you see those declines looking? When is Canada going to come off - if you like - the plateau, the shoulder, and what could that look like as we go into decline, serious decline?

How will natural gas decline look like for Canada?

DH: Just depends on the price of gas, really - depends on what happens this winter. If we have another warm winter, a lot of gas in storage in North America right now - if we get lucky, we may be able to ride this out for two or three years before we really start to see the declines. If we have a few cold winters, the price of gas will spike, and there'll be a lot more drilling. So that could, in fact - if we don't use it all up heating our houses and in our industry - that could, in fact, see growth in gas supply - only because of feverish drilling. There's also a question: are there enough rigs, are there enough people that know how to run those rigs, to actually allow that to happen? Because, for a while, there, we were pretty much 100% utilized, and so unless we really bring more equipment onto the market, it's doubtful that we can maintain the levels of drilling to keep production growing.

JD: Can we maintain a level of discovery so that there's something to drill?

Can the level of discoveries be maintained?

DH: We have been doing that. Basically, in terms of Canada's gas - remaining gas resources, discovered and undiscovered - roughly 77% of what's left - if you look at the statistical analysis - it hasn't been found yet. We know that the undiscovered resources are in much smaller pools than the pools that we've discovered. We need a lot more wells to find smaller and smaller pools. Whether we can do that, I doubt it. If you look at the reserve replacement - so, we look at the amount of gas discoveries versus the amount of gas produced - of recently, say the last 10 years, we've never discovered as much gas as we've produced in any one year. So, our proven reserve base has been falling consistently. I think there is one year, in 2001, when we actually found as much gas as we used - a little bit more - and another year, in 2004, where we found almost exactly as much gas as we used. But, in every other year, we haven't been finding enough new gas to replace the gas that we've been using.

JD: Can you say something about this number of pools, the - I think you mentioned 44,000 - actually use the numbers, and explain where we've been, and where we're going with this dramatic increase in the number of pools, and why that's a problem?

What do pools mean, when we talk about natural gas supplies?

DH: The assessment of discovered and undiscovered gas is based on statistical methodology. So, we look at what's called pool size distributions - discovered and undiscovered - and we can make an estimate of how many undiscovered pools are left, and the size of those pools. I'm also on the Canadian Gas Potential Committee - a group of senior geoscientists that prepares periodic national assessments of Canada's discovered and undiscovered gas resources - and in our most recent assessment, on the conventional gas side, in the Western Canada Sedimentary Basin, the two-thirds of the gas that we found were contained in 44,000 pools. The one-third of the gas that we haven't discovered, yet, is contained in 500,000 pools. And the last 200,000-300,000 pools on that tail will be far too small to be commercially developed. So, roughly 90% of what's left of the undiscovered resources are contained in probably 250,000 pools. It takes us two wells to find each one - that's 500,000 wells to find the last 30% of Canada's gas. To put that in perspective: we've drilled 300,000 wells to find the first 70%, so we can see that's the treadmill, the law of diminishing returns.

JD: Can you say something about Canada's conventional oil - where it is, and what's the future like for that?

Can you comment on Canada's conventional oil supply and why it needs to import it?

DH: In terms of importing conventional oil, that's really a transportation issue. The imported oil comes in into Eastern Canada, and there's no real capacity to move western oil to Eastern Canada - it makes more sense to bring it in from offshore. Where is the oil in Canada? The bulk of it's in the Western Canada Sedimentary Basin. We do have offshore oil deposits, off the coast of Newfoundland - there are some new developments that are coming on off the East Coast. But, when you add it all up, Canada's conventional oil - even with the new developments of the east coast - is in decline. So, the only real growth and supply out of Canada is the oil sands.

JD: You mentioned this interesting importing situation. Could you say a little bit more about this? This, maybe, is a surprise to Canadians because Canada looks like a fairly sizeable exporter to the U.S. (and it is), but there's a flip side.

How much oil does Canada import?

DH: Canada exports a little under 2 million barrels a day to the U.S. Canada imports about a million barrels a day - or a little more - into Eastern Canada, which comes as a great surprise to most people - even to me (until I really looked into it, I didn't realize the magnitude). And Canada's imports of oil have tripled since 1985, which also came as a big surprise to me. So, if you subtract Canadian imports from Canadian exports, Canada's a net exporter of less than a million barrels a day in a world oil market of 85 to 86 million barrels per day. So, significant for Canada: Canada will be able to meet its domestic demands likely out through 2025 or 2030, according to the forecasts. But, a drop in the bucket, even with the growth in the oil sands - in terms of offsetting conventional global declines of conventional oil.

JD: Turning to the tar sands, the oil sands. Can you say a bit to help people understand what's going on there, and then we'll come to the gas connection? But, just so people understand that the tar sands - all oil is not created equal, and, in fact, that's bitumen up there. If you can say something to explain to people what's really going on, I think that would be very helpful.

Can you explain what kind of oil is extracted from the tar sands?

DH: I like to talk about the food chain when it comes to oil - conventional and unconventional. When we drill an oil well - really, this is a comment on energy return on investment - so, how much energy do we spend developing the resource versus the energy that we get back from the resource that we recovered? And when we drilled a vertical well in Saudi Arabia back in the 1950s, the energy that it took us to drill that well versus the energy in the 20 thousand barrels a day that we got back, was 100:1, or greater. As we go to new conventional oil, we're using a lot more technology to find it, it's in smaller pools, there's no other Ghawar pools [yet to be found], Ghawar is the largest pool in the world, found in 1948. So, the new conventional oil is 3D seismic, horizontal, multilateral wells, offshore oil. You can look at the investment in the so-called Jack 2 discovery in the Gulf of Mexico, which was ballyhooed as a panacea by some, back in September. There's only one rig in the world that can drill to those depths. Now, we are exploring in 7,000 feet of water, drilling holes another 25,000 feet deep to get our oil. So, the investment of energy in those kinds of deposits is very high. It costs them $100 million to drill that hole, and $100 million to complete it, and it may not be economic. Why would they do that? Because there's no better place to look. If you look at oil sands - again, they're very low-grade oil, they require upgrading to turn it into synthetic crude, which is something that can actually be used - I think the ratio is something like two tonnes of oil sand for one barrel of oil - that's moved by trucks (hydrocarbons, diesel fuel). It's upgraded with natural gas, water. So, the energy input for tar sands is on the order of two to one. So, we burn a barrel to get two - with all of the greenhouse gas implications of doing that. So, as we move down the food chain, from 1950’s Saudi Arabia to oil sands in 2006, we're committing more and more hydrocarbon consumption, just to get hydrocarbons. And you can see the greenhouse gas implications of doing that. How much can the oil sands can grow? I've looked at all the forecasts (they change yearly), I've looked at all of the 2006 forecasts, and I've looked at the cost overruns (the amount of money companies are investing in capital for one barrel per day increase in capacity). And those costs have gone up more than double for Shell's new project, for example. And if you assume that those costs will be the costs that you have to spend to get the infrastructure growth; by my calculations, if we spend $90 billion (which is on the table right now), we may be able to get the oil sands to 2 million to 2.5 million barrels per day. And, again, that's going to keep Canadians in oil. It's going to result in a huge increase in greenhouse gas emissions. And, if you fire up GoogleEarth and go north of Fort McMurray and have a look at the surface - environmental impact of those oil sands - we're going to have a major ecological issue for those 2.5 million barrels per day of oil, a lot of which will be exported to our neighbors to the South.

JD: What is your estimate of the marginal barrel price now? It used to be $40 a barrel per day.

What is your estimate of the marginal barrel price?

DH: And again, there's oil sands deposits and there's oil sand deposits. Oil sands deposits are on the same food chain, although at a lower level than other oil deposits. The thing that really works is the surface mineable oil sands. And those, generally, are less than 70 meters depth. And, again, it's difficult to get really good numbers, but I've heard numbers like $35 or $40 - that's what you need. The in-situ part of the resource is developed by drilling horizontal wells, pumping in steam to liquidize the bitumen, and then recovering it - it's much more energy intensive on the recovery end than surface mining, but it's most of what's up there. If you look at the EUB numbers [Provincial Alberta Energy Utilities Board], I think it's about 20% surface mineable, 80% in-situ. And some of that in- situ is - maybe in-situ you can get it for $35 or $40 per barrel - some of it is much lower quality - it might need $50, $60, or more in order to get it out. And, again, a lot more energy input per barrel when you're going to the lower and lower quality in-situ resources.

JD: Now, are you talking about the price per barrel, as on Nymex, or the amount of capital investment per marginal barrel?

Is this the price per barrel on a commodities market?

DH: Really, I'm assuming that with capital investment and all of the economics worked out, they need $40 or more to get a return on their investment [which varies depending on the quality of the resource]

JD: That's the price of oil?

DH: Yes. The Nymex price of oil would have to be $40 or higher. But, again, I expect those numbers are a moving target because the infrastructure cost has been an incredible moving target over the last three or four years. And, again, one of the reasons there's such a frenzy in the oil sands is there's not many other good places to look in the world. If you look at what's left of the reported world's oil reserves, somewhere between 70% and 80% are controlled by nationalized oil companies, so they're off limits to multinationals. Canada's, politically, is a very safe place to invest your money, so it's very attractive for them, compared to drilling a Jack 2 well for $200 million and having it come in as a [potentially] non-economic entity.

JD: What do you think of Canada being trumpeted as having more reserves than - or, at least, being equivalent to the new Saudi Arabia?

Comment on the statement: "Canada the new Saudi Arabia" DH: I think it's very misleading. I don't question that the reserves are there. The whole issue is how fast can you convert them to supply. And that's the whole problem with oil sands: it takes a long time to build the infrastructure, and to grow deliverability, compared to drilling a 1950 well in Saudi Arabia. So, it's a deliverability issue, not a resource issue. There's a study done at Uppsala University in Sweden on the oil sands, the implications of a crash program - if you didn't worry about natural gas limitations, water limitations, environmental impact limitations - how fast - or, the whole inflation situation that's happening in Fort McMurray because of all the development. If we didn't worry about any of that, and said, how much could we get if we just went flat out, and their analysis was that the oil sands would peak in 2038 at about five million barrels per day. And that's, again, significant, but the forecast [global] demand at that time is over 120 million barrels a day. So, compared to what the world needs, it's still a small part. And, the other thing about that analysis is, by 2050, all of the surface mineable oil sands will be gone, so we'll be left just with what we may, or may not, be able to recover from the in-situ [resources].

JD: You've mentioned gas. Can you bring gas into the tar sands, the oil sands picture, and explain how that - how that is now looking to you, what are your concerns about that, and how does it fit in the picture?

How does natural gas fit into the tar sands picture?

DH: A lot of gas is used in the oil sands. It's about three-quarters of an Mcf per barrel for surface mineable. I'm not sure if that's taking all of the uses into account. That's the - the Alberta Chamber Resource's number. That takes 1.5 Mcf per barrel for the in-situ. And, again, I would expect that that would change with the quality of the in-situ resource you're trying to develop. That gas is used for steam, [and as a] source of hydrogen in the upgrading process. If we continue with the existing methodologies in the oil sands, we're looking at - if we can get to 2.5 million barrels a day - we're probably looking at 2.3 billion cubic feet per day of natural gas supply that's required - in the face of a tenuous conventional supply of gas, especially if we play this out for a few years. If we look at bringing new gas in from say the Arctic, the Beaufort McKenzie, the known deposits in the Beaufort McKenzie are about 6 trillion cubic feet. That's what the economics of the McKenzie Valley Pipeline have to be based on, and we think we're going to find more. But, right now, that's what we've got in order to build the McKenzie Valley Pipeline. And the planned maximum capacity of that pipeline is 1.9 Bcf a day, or billion cubic feet per day. In the face of a 2.3 billion cubic feet per day requirement, just for the oil sands. So the McKenzie Valley Pipeline is not a panacea to offset declines in conventional production, unless we find some other way to recover the oil from the oil sands. And there are things that people are looking at: coal gasification, potentially, bitumen gasification - that's still experimental at this point in time. And if we go to that, we know that greenhouse gas emissions per barrel of oil are only going up.

JD: The greenhouse gas situation in terms of Canada and Canadian politics is not exactly clear cut, but it does seem to have taken a - it does seem to be heading in the direction of being less worried about it. What light can you shed on that picture?

Can you comment on the greenhouse gas situation in Canadian politics?

DH: Canada has been a bit of a bad offender when you look at greenhouse gas emissions growth. Since 1990, Kyoto was supposed to get us down to 6% below 1990 by 2012, I believe. What's actually happened is we're now about 30 odd percent above 1990 levels, which requires a horrific decrease in greenhouse gas emissions. The Liberals said we were going to do it, but if you look at what happened, greenhouse gas emissions just kept rising. The Conservatives are backing off on Kyoto. In a way, I sort of agree with them. I can't see [with] people committed to business as usual, how we're going to get a cut of 36% by 2012. I see a lot of inertia. I don't see things happening - in fact, I can see things getting worse with the developments at Fort McMurray. So, they might have been realistic in assuming that we can't meet those targets. What really disturbs me is we're looking around the world to try to maintain business as usual without realising that we have an oil problem, a natural gas problem. There are things that we could and should be doing to reduce our consumption of those resources, as opposed to desperately trying to find more to keep business as usual going. I think we have to kind of wake up and smell the roses, and start doing those things. And that's the only way we're going to manage the greenhouse gas problem, or the long-term energy sustainability problem.

JD: What do you think some of the implications of the Canadian energy situation are - in all its complexities with both gas and oil (however we come by that oil) - for America. I mean, this is a pretty tightly knit pair of countries when it comes to energy. Do you think the Americans are aware of the situation in Canada?

How does Canada's energy situation affect the United States?

DH: Depends on which Americans you're talking to. I think they're being overly optimistic about what they can expect out of Canada. I was at the ASPO Boston Conference about a month ago. I gave a talk on Canadian natural gas, and my impression was a lot of people were really shaken up by the implications because they really didn't understand the fact that Canada is almost in as bad a position as the Lower 48 in terms of trying to grow gas supply. They sort of thought, well, there's some kind of magic solution north of the border, and I told them, sorry, this is the data, don't count on us. On the oil side: again, there's a lot of hype about the oil sands. But, by my calculations, we might get them up to 2.5 million barrels a day - we have to use some of that ourselves because our conventional oil is declining. The U.S. is now importing over 13 million barrels a day, so if they get 1.5 from us, they still need to get 11.5 from somebody else. Mexico was number two after Canada as a source of oil, and their oil [production] looks like it's rolling over - they're not making the investments - their Cantarell field has peaked, and now is in quite steep decline. Meanwhile, domestic consumption of oil in Mexico is going up. Their ability to export to the U.S., I don't think, will rise again in the foreseeable future. Hugo Chavez looks like he's just going to win another election. He's really not making the investment required to grow Venezuelan oil production. As well, the U.S. is not one of his most popular clients, and he's looking around the world for other eager clients, such as China, which is more than happy to do a deal. Nigeria has its problems with terrorism and political unrest, in essence. So, when you look around the world, it's hard to see where the U.S. is going to be able to continue growing its oil imports. Matt Simmons made the point: what's happening in Mexico is extremely dangerous for the U.S. going forward.

JD: And then turning to coal to liquids, which is another of the technologies which is being presented to us as a way out of the liquids fuel problems - do you have any experience or knowledge in terms of the costs, the construction time, the volume of coal in terms of the amount of coal you need in comparison to the amount of oil you get?

Can you comment on coal to liquid technology?

DH: The Sasol process used in South Africa (and now used in many other places in the world) shows it works. I mean, you can make liquids out of coal and petrochemicals out of coal. The infrastructure implications are huge - in terms of the amount of capital that has to be invested - and the volumes of oil that you get out from that process are quite low. Hirsh has actually got some numbers, I believe, in his report on coal to liquids. I guess, my comment would be that coal to liquids, from an energy return on investment point of view, would be quite low - probably in the range of oil sands - it may be 2 or 3 to one - with the same kind of time frames that are required. I mentioned earlier that U.S. coal production has essentially peaked. They're now importing - they're importing coal from, I believe, Venezuela or Colombia for the last three years, so. Coal is there, of course, in abundance. But it's no panacea for business as usual to offset declines in conventional [oil production] because of the same problems as the oil sands. It's likely to be a small, incremental supply - that's all I can say.

JD: Do you feel that some change will happen at a political level, some time soon in Canada?

Can change happen at a political level in Canada?

DH: It seems in North America that the people react to things, as opposed to being pro-active. Maybe that'll change, but I don't see any evidence of that at this point in time. I hate to say it, but probably what we really need is another major hurricane in the Gulf, or some incident in Iran – [which has] 4 million barrels a day [of production, nearly 5% of global production]. Take a bunch of oil off the market; that will really make people see the risk that we are putting ourselves in. And those kinds of shocks will wake up the public, as well. And the public, really, is what motivates politicians to react.

MediaDavid Hughes on Canada's Oil and Natural Gas - updated with audio