>> SAUDI PROOF PORTFOLIOS?

Forecast of Rising Oil Demand Challenges Tired Saudi Fields
By JEFF GERTH
When visitors tour the headquarters of Saudi Arabia's oil empire -- a sleek glass building rising from the desert in Dhahran near the Persian Gulf -- they are reminded of its mission in a film projected on a giant screen. "We supply what the world demands every day," it declares.
For decades, that has largely been true. Ever since its rich reserves were discovered more than a half-century ago, Saudi Arabia has pumped the oil needed to keep pace with rising needs, becoming the mainstay of the global energy markets.
But the country's oil fields now are in decline, prompting industry and government officials to raise serious questions about whether the kingdom will be able to satisfy the world's thirst for oil in coming years.
Energy forecasts call for Saudi Arabia to almost double its output in the next decade and after. Oil executives and government officials in the United States and Saudi Arabia, however, say capacity will probably stall near current levels, potentially creating a significant gap in the global energy supply.
Outsiders have not had access to detailed production data from Saudi Aramco, the state-owned oil company, for more than 20 years. But interviews in recent months with experts on Saudi oil fields provided a rare look inside the business and suggested looming problems.
An internal Saudi Aramco plan, the experts said, estimates total production capacity in 2011 at 10.15 million barrels a day, about the current capacity. But to meet expected world demand, the United States Department of Energy's research arm says Saudi Arabia will need to produce 13.6 million barrels a day by 2010 and 19.5 million barrels a day by 2020.
"In the past, the world has counted on Saudi Arabia," one senior Saudi oil executive said. "Now I don't see how long it can be maintained."
Saudi Arabia, the leading exporter for three decades, is not running out of oil. Industry officials are finding, however, that it is becoming more difficult or expensive to extract it. Today, the country produces about eight million barrels a day, roughly one-tenth of the world's needs. It is the top foreign supplier to the United States, the world's leading energy consumer.
Fears of a future energy gap could, of course, turn out to be unfounded. Predictions of oil market behavior have often proved wrong.
But if Saudi production falls short, industry experts say the consequences could be significant. Other large producers, like Russia and Iraq, do not have Saudi Aramco's huge reserves or excess oil capacity to export, and promising new fields elsewhere are not expected to deliver enough oil to make up the difference.
As a result, supplies could tighten and oil prices could increase. The global economy could feel the ripples; previous spikes in oil prices have helped cause recessions, though high oil prices in the last year or so have not slowed strong growth.
Saudi Aramco says its dominance in world oil markets will grow because, "if required," it can expand its capacity to 12 million barrels a day or more by "making necessary investments," according to written responses to questions submitted by The New York Times.
But some experts are skeptical. Edward O. Price Jr., a former top Saudi Aramco and Chevron executive and a leading United States government adviser, says he believes that Saudi Arabia can pump up to 12 million barrels a day "for a few years." But "the world should not expect more from the Saudis," he said. He expects global oil markets to be in short supply by 2015.
Fatih Birol, the chief economist for the International Energy Agency, said the Saudis would not be able to increase production enough for future needs without large-scale foreign investment.
The I.E.A., an independent agency founded by energy-consuming nations, and Washington see investment in energy exploration and field maintenance as vital, but such proposals face strong opposition inside Saudi Arabia. Tensions with the West, particularly the United States, make such investment politically difficult for Saudi society. For example, an effort by Crown Prince Abdullah, the kingdom's de facto ruler, to encourage Western companies to invest $25 billion in his country's natural gas industry essentially collapsed last year.
"Access to Persian Gulf oil reserves, especially Saudi Arabia's, is the key question for the whole world," Dr. Birol said.
President Bush has said he wants to make the United States less reliant on oil-producing countries that "don't like America" by diversifying suppliers and financing research into hydrogen fuel cells, but achieving that remains far off.
His administration backs foreign investment initiatives in the gulf region, including Saudi Arabia, and his energy policies rely on Energy Department projections showing the world even more dependent on Arabian oil in 20 years. That may be enough time for governments to find alternatives, but oil field development requires years of planning and work.
Publicly, Saudi oil executives express optimism about the future of their industry. Some economists are equally optimistic that if oil prices rise high enough, advanced recovery techniques will be applied, averting supply problems.
But privately, some Saudi oil officials are less sanguine.
"We don't see us as the ones making sure the oil is there for the rest of the world," one senior executive said in an interview. A Saudi Aramco official cautioned that even the attempt to get up to 12 million barrels a day would "wreak havoc within a decade," by causing damage to the oil fields.
In an unusual public statement, Sadad al-Husseini, Saudi Aramco's second-ranking executive and its leading geologist, warned at an oil conference in Jakarta in 2002 that global "natural declines in existing capacity are real and must be replaced."
Dr. al-Husseini, one Western oil expert said, has been "the brains of Saudi Aramco's exploration and production." But he has told associates that he plans to resign soon, and his departure, government oil experts in the United States and Saudi Arabia say, could hinder Saudi efforts to bolster production or entice foreign investment.
Saudi Arabia's reported proven reserves, more than 250 billion barrels, are one-fourth of the world's total. The most significant is Ghawar. Discovered in 1948, the 300-mile-long sliver near the Persian Gulf is the world's largest oil field and accounts for more than half of the kingdom's production.
The company told The New York Times that its field production practices, including those at Ghawar, were "at optimum levels" and the risk of steep declines was negligible. But Mr. Price, the former vice president for exploration and production at Saudi Aramco, says that North Ghawar, the most valuable section of the field, was pushed too hard in the past.
"Instead of spreading the production to other fields or areas," Mr. Price said, the Saudis concentrated on North Ghawar. That "accelerated the depletion rate and the time to uncontrolled decline," or the point where the field's production drops dramatically, he said.
In Saudi Arabia, seawater is injected into the giant fields to help move the oil toward the top of the reservoir. But over time, the volume of water that is lifted along with the oil increases, and the volume of oil declines proportionally. Eventually, it becomes uneconomical to extract the oil. There is also a risk that the field can become unstable and collapse.
Ghawar is still far too productive to abandon. But because of increasing problems with managing the water, one Saudi oil executive said, "Ghawar is becoming very costly to maintain."
The average decline rate in Saudi Aramco's mature fields -- Ghawar and a few others -- "is in the range of 8 percent per year," without additional remediation, according to the company's statement. This means several hundred thousand barrels of daily oil production would have to be added every year just to make up for the diminished output.
Every oil field is unique, and experts cannot predict how long each might last. For its part, Saudi Aramco is counting on Ghawar for years to come.
The company projects that Ghawar will continue to produce more than half its oil. One internal company estimate from 2002 puts Ghawar's production at 5.25 million barrels a day in 2011, more than half the total expected crude oil capacity of 10.15 million, according to United States government officials and oil executives.
"The big risk in Saudi Arabia is that Ghawar's rate of decline increases to an alarming point," said Ali Morteza Samsam Bakhtiari, a senior official with the National Iranian Oil Company. "That will set bells ringing all over the oil world because Ghawar underpins Saudi output and Saudi undergirds worldwide production."
The I.E.A. warned in November that huge investments would be needed to offset the decline rates in mature Middle Eastern oil fields -- it put the average at 5 percent -- and the increasing costs of oil and gas production. The agency, based in Paris, forecasts that Saudi production will need to reach 20 million barrels a day by 2020. (I.E.A. and other research estimates say that more than 90 percent of that would be crude oil; the rest would be liquid products like natural gas liquids that result from the processing of crude oil.)
In his speech in Jakarta, Dr. al-Husseini noted the need for exploration, pointing out that colleagues at Exxon Mobil predict that more than 50 percent of oil and gas consumption in 2010 must come from new fields and reservoirs.
Harry A. Longwell, the executive vice president of Exxon Mobil, says finding new sources of oil is crucial. Mr. Longwell, in an interview, said that increasing demand and declining production were not new problems, but they were "much larger now because of the world's demand for energy and the magnitude of the numbers now are much larger."
To offset its declines, Saudi Aramco is bringing back into production one idle field, Qatif, and is enhancing production at a nearby offshore field, Abu Safah. The company says that with expert management, these fields will produce about 800,000 barrels a day.
But current and former Saudi Aramco executives question those expectations, contending that the goal of 500,000 barrels a day for Qatif is unrealistic and that development costs are higher than anticipated.
Qatif poses real difficulties. It is near housing for Saudi Arabia's minority Shiite population and contains high concentrations of hydrogen sulfide, a highly toxic gas. Its development is "particularly challenging," according to a technical paper by Saudi Aramco engineers presented last year in Bahrain, which said that 45 percent of potential drilling sites "were rejected due to safety concerns."
At Abu Safah, Saudi Aramco has experienced increasing water problems as it has turned to submersible pumps to extract oil. Experts, including American and Saudi government officials, say the technique is ill advised. Saudi Aramco, in its written response to questions, defended the use of the pumps at Abu Safah and its ability to manage the water after 37 years of production.
One United Sates government energy expert noted that "submersible pumps is what the Soviets went to on an indiscriminate basis in West Siberia and it went south." Samotlor, a huge field in Siberia, once produced more than three million barrels a day, but it declined sharply in the 1980's after the Soviets pushed it too hard. Today it produces only a few hundred thousand barrels a day.
Copyright 2004 The New York Times Company

----------------------------------------------------------------
15 drillers to fuel your portfolio

Natural-gas exploration is still a crapshoot, but the stakes have grown tantalizingly higher. Back the right stock and both of you emerge big winners.

By Jon D. Markman

For investors interested in intellectually-advantaged speculation seasoned with a dash of geopolitical gaming, it may be time to step on the gas.

The broad-brush reasons for taking positions in small-cap North American energy exploration companies has been in place for some time, as China has emerged as a voracious devourer of energy, Saudi Arabian turmoil has intensified (See "Saud's royal house of cards"), U.S. state governments have demanded wider use of clean-burning fuels by power plants and environmental laws have tightened supplies.

Early-bird speculators have therefore pushed up prices of some of the best little explorers, such as Ultra Petroleum (UPL, news, msgs) and Callon Petroleum (CPE, news, msgs) by as much as 100% over the past 10 months. But most of these stocks have cooled recently, providing a new entry point for a second wave of investors and traders seeking a hedge against overseas uncertainty.

To be sure, drillers defile the landscape of some of the most gorgeous places on earth like filthy rows of steel stinkbugs. Yet they are a necessary evil, angels disguised as devils, and their ugliness masks opportunity.

Natural gas' increasing value
Big picture first: Back in the 1940s, natural gas was worth virtually nothing. Drillers burned it off in the process of exploring for petroleum. As new uses were discovered, it became increasingly valuable, rising from $2 per 1,000 cubic feet on average during the 1990s to $10 in 2000. The price collapsed in 2001 back to $2, but it has steadily risen since -- spiking above $10 at the start of last year's war in Iraq before settling back to around $5.25, where it is now.Your money, fast.

The price of natural gas always jumps during winter cold snaps, which accounted for its most recent foray above $5.75, but it's unlikely to collapse below its current trading range again because there's not enough drilling being done to satisfy demand due to tough environment laws. Federal Reserve Chairman Alan Greenspan told Congress back in June that tight supply threatened the U.S. economy.

An `all or nothing' world
All gas drillers are not equal, and it pays to understand the industry's superstructure, risks and leverage points. Just as technology investors are accustomed to learning about the varied makers of semiconductors, disk drives and switches that make components for popular consumer electronics devices and determining which offer the most oomph at various points in the economic cycle, energy investors must learn about the complex, high-risk way gas is discovered and distributed.

Lesson No. 1, though, is how truly speculative some of these guys are. The companies are usually run by cagy industry veterans -- some with checkered pasts -- who suspect they can use new high-tech 3-D seismic imaging tools to find gas formations in properties abandoned by much larger drillers, such as Exxon Mobil (XOM, news, msgs) or ChevronTexaco (CVX, news, msgs). At the start of new projects, observers are skeptical that the driller will even find financing to start the project. Then, they're skeptical they'll persuade an oil-services company to lease them a drilling rig. Then, they're skeptical that drilling will ever actually start. Then, they're skeptical that the project will ever be completed. And then -- and lastly, they wait anxiously to learn whether gas is discovered or not.

Drilling is thus a crapshoot of probability distributions, and as each critical hurdle is cleared, energy speculators become more interested, adding to their positions and pushing up stock prices. The big moment comes when the company announces whether it has hit pay dirt or come up dry. The final press release announcing the success or failure of a new well is like the one that is published when a biotech company tells the world whether the U.S. Food and Drug Administration has approved its cure for cancer. It's all or nothing, hero or goat.

Canadian Superior Energy
Canadian Superior Energy (SNG, news, msgs) is typical of this high-risk/high-reward world. The company, which already owned leases to drill in Trinidad and western Canada, obtained four offshore exploration licenses totaling 933,000 acres in relatively shallow water off Nova Scotia a few years ago. In April last year, it announced it had teamed with gas pipeline giant El Paso (EP, news, msgs) to drill an extremely deep well -- about 18,000 feet -- in a property off Halifax known as Mariner Prospect. In June, Canadian Superior cleared a big hurdle by announcing that El Paso would provide half the project's $30 million cost for half the profits, and in November it cleared further hurdles by completing a $14 million private placement, securing a drilling rig from Rowan (RDC, news, msgs) and started to drill. The stock over this period went from 80 cents to $3.03; it's now around $2.65.

The largest institutional shareholder of the stock, at 6.5% of the outstanding shares, is Palo Alto Investors (PAI), a private, value-oriented hedge fund in Northern California. David Anderson, the analyst on the hook for the investment at PAI, says he believes the value of the company's other properties in Western Canada provide the bedrock for the share price today, and the Nova Scotia project could add $5 to $8 if the company meets its goal of drilling into the middle of a formation with 1 trillion cubic feet of gas. "As a value player, we see a lot of optionality," he said, meaning that the stock is like a call option on the Mariner project.

Two weeks ago, Anderson flew out to the rig on a helicopter in 60 mph winds and hung around for a while despite 30-foot seas. He said he learned Canadian had 4,000 more feet to drill, that the drilling personnel were "fantastic" and that there have been "gas shows" along the way. But he said that neither he, the crew bosses nor company executives had any idea yet whether the project would be successful. "It's sort of like the swordsman who lives to fight another day," he said. "Every day they drill without doing anything wrong removes a little uncertainty, but until they get to 18,000 feet and do some expensive tests there, it's still just a speculation."

Cheap, strong explorers
The day of truth will come in about three weeks. In the meantime, Anderson, whose hedge fund was up 90% last year and has compounded returns of 25% over the past 14 years, has been quietly investing in several other exploration ventures that he declined to reveal. He primarily buys drillers with high "recycle ratios." It's a simple concept: Find companies with proven ability to replace the oil or gas they're extracting from the ground for much less than the production costs and the expected future commodity price. If you can sell gas for $5.50 that costs $1.50 to find and make, you can use some of the profits to explore for more. "The key thing is to replace your depleted asset at low costs, and if you can provably do that repeatedly -- fantastic," Anderson said. And, he added, all the information necessary to make such judgments can be found in the footnotes of explorers' annual 10K filings with the U.S. Securities and Exchange Commission.

Not including the ones he's currently buying, Anderson said he believes the strongest, least expensive explorers at this time are small caps PetroQuest Energy (PQUE, news, msgs), Patina Oil & Gas (POG, news, msgs), Wiser Oil (WZR, news, msgs), Harvest Natural Resources (HNR, news, msgs), Callon Petroleum and Meridian Resources (TMR, news, msgs); and midcaps Ultra Petroleum, XTO Energy (XTO, news, msgs), Evergreen Resources (EVG, news, msgs), Newfield Exploration (NFX, news, msgs) and Pogo Producing (PPP, news, msgs).

Ultra Petroleum is a good example. Although it has properties in Pennsylvania and China, Ultra's main asset is in the Pinedale Anticline of Wyoming, located southeast of Jackson Hole. A company typically does great if it hits oil in half the wells it sinks, but Ultra is virtually 100 for 100 in Wyoming and has more than 700 drilling prospects left. That makes it a "reserves growth" story that Anderson believes is worth $30 to $40 -- about 50% more than the current price. (His firm owns 1 million shares.) Likewise, Harvest Natural Resources is a low-cost producer off the coast of Venezuela that might be undervalued because of political risk stemming from the unstable regime of President Hugo Chavez. Anderson considers Chief Executive Peter Hill one of the industry's best.
Side bets abound. Consider drilling technology provider Carbo Ceramics (CRR, news, msgs), a small-cap maker of little clay balls that are used to prop open fractured rock underground, increasing oilfield yield. Or Golar LNG (GLNG, news, msgs) a fast-growing, profitable but inexpensive Norwegian shipping company that specializes in transporting liquefied natural gas. For returns less subject to the whims of commodity prices, check out large-caps Halliburton (HAL, news, msgs) and Schlumberger (SLB, news, msgs), without whose oilfield management and services expertise worldwide drilling would come to a standstill.
Over the rest of the year, I'll explore the industry further and visit some rigs for a more personal account. Initial ideas are listed in the table below.

Natural gas exploration picks
Company Market cap Chg. 2003 Scouter rating 2/17 price
PetroQuest Energy (PQUE, news, msgs) $114 million -13.8% 4 $2.84
Canadian Superior Energy (SNG, news, msgs) $233 million 149.5% 5 $2.56
Meridian Resource (TMR, news, msgs) $333 million 318.5% 4 $5.58
Wiser Oil (WZR, news, msgs) $126 million 141.1% 6 $8.17
Harvest Natural Resources (HNR, news, msgs) $393 million 73.7% 5 $11.58
Golar LNG (GLNG, news, msgs) $977 million 188.4% NA $16.19
Ultra Petroleum (UPL, news, msgs) $1.7 billion 140.2% 6 $25.84
XTO Energy (XTO, news, msgs) $4.8 billion 43.4% 9 $28.53
Halliburton (HAL, news, msgs) $13 billion 57.0% 10 $31.79
Evergreen Resources (EVG, news, msgs). $1.2 billion 49.4% 8 $35.10
Pogo Producing (PPP, news, msgs) $2.6 billion 12.7% 8 $44.83
Patina Oil & Gas (POG, news, msgs) $1.5 billion 68.6% 8 $49.46
Newfield Exploration (NFX, news, msgs) $2.6 billion 42.4% 8 $46.38
Carbo Ceramics (CRR, news, msgs) $911 million 77.1% 7 $59.55
Schlumberger (SLB, news, msgs) $35 billion 63.2% 8 $64.07



Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm68@lycos.com. At the time of publication, Markman did not have positions in any securities mentioned in this column. His newsletter described Canadian Superior in its Dec. 3, 2003 issue.