Monday, July 25, 2005

The Enron of OPEC

Recently, I watched a screening of "Enron: The Smartest Guys in the Room," a documentary about the Enron scandal and collapse. But, having just completed Matthew Simmons' "Twilight in the Desert," I couldn't help thinking about the world's largest oil company, Saudi Aramco, the national oil company of Saudi Arabia. In the case of Enron Wall Street analysts were almost unanimously too polite to ask the company to show them one crucial thing: how the company made its money. The analysts admitted that Enron was a "black box" and that they just had to take company revenues and earnings on faith. As long as the stock was rising, few people questioned what was going on at Enron.

Like their Wall Street counterparts, energy analysts seem to regard Saudi Aramco as a "black box" whose claims must be taken on faith. The company frequently says it can reach 15 million barrels per day in oil production and maintain that level for 50 years. The proof they offer: "Trust us!" In fact, there has been virtually no independent information about oil in Saudi Arabia since the early 1980s with one important exception: technical papers on file with the Society of Petroleum Engineers. These papers form the basis of Simmons' book, and they cast considerable doubt on claims by the Saudis that they will be able to sustain continuing high production levels for decades.

In the case of Enron the obfuscation and deception appeared on the surface to be part of a conscious strategy to increase the stock price. That meant 10s of millions of dollars for the top managers who sold out before the company collapsed. What motive could Aramco officials have for deceiving the world about its ability to produce oil? Aramco is not a publicly traded company, and so, greedy managers looking to cash in their stock options is not an explanation. However, Saudi Arabia would surely forfeit its premiere position among the world's oil producers if oil experts suspected that Saudi supplies were about to go into decline.

But, all this assumes a conscious strategy of deception. There may be something more troubling at work. As the Enron documentary illustrated, there were many employees--even in top management--who for a long time believed that the company would succeed. That is, they believed their own hype. Could it be that Saudi Aramco officials believe their own hype? After all, the company has been the world's leading producer of oil and has a reputation for cutting edge technology and talented management. And, it has a chorus of cheerleaders from the outside. Among them is perhaps the world's most well-informed oil supply expert, Thomas Ahlbrandt, the head of the U. S. Geological Survey's World Petroleum Assessment, the most thorough study of worldwide oil supplies ever undertaken. I had a conversation with Ahlbrandt last year. He said he worked in Saudi Arabia extensively as a petroleum geologist before joining the USGS and knew the Saudis well. He believes they have the oil they say they do.

With an endorsement like that why should any of the world's energy analysts doubt Saudi Aramco? And, yet the same phenomenon occurred with Wall Street analysts who almost unanimously agreed that Enron was the next big thing. If so many influential analysts knew that Enron was a sound investment, then there appeared to be no need for the kind of scrutiny that other lesser known companies might require.

Perhaps the most disquieting possibility this analogy points to is the rapid decline of Saudi oil supplies. Saudi Aramco has been using the most advanced recovery techniques in the industry for years. While these techniques have been able to maintain high rates of production, those rates may have come with a cost. In "Twilight in the Desert" Simmons says that the history of other giant oilfields subjected to the latest oil recovery technology--he cites the case of the North Sea oilfields--shows that once decline sets in it can be rapid. North Sea production in the British sector is down more than 30 percent since the peak in 1999.

And, so it was with Enron. When the decline came, it was sudden, catching most of the investment community by surprise. Enron had a huge public following and the confidence of virtually everyone on Wall Street practically right up to the end. It was conventional wisdom that Enron could only get bigger and better.

With Saudi Aramco, is it a case of self-deception or conscious bluff? In fact, it may be a little of both. The company has pulled off heroic feats of production in the past. Perhaps these past successes make Aramco officials and the company's outside cheerleaders believe Aramco can recreate the Saudi oil miracle all over again. But, there must be some conscious bluffing in the company's approach as well. Once Aramco learned that Simmons was writing a book critical of its cornucopian claims, it began a public relations campaign to reassure the world that Aramco can supply a large part of our future petroleum needs. (A recent sample of that campaign can be found here. It has the quality of a political campaign based more on endless repetition than actual information.) But, Aramco has released very little new information in the process of this campaign. The company is essentially reiterating its "trust us" message, albeit dressed up a little more formally. (Large downward reserve revisions by Shell last year have now made "trust us" a less credible message.)

All the Saudis would have to do to refute Simmons and other critics is to release detailed oilfield data and allow independent audits. So far, they have refused, and no one expects them to change their minds.

Draw your own conclusions.

4 comments:

step back said...

Kurt,
Still slogging through "Conspiracy of Fools" -another Enron book.

In a large population of players, each has his or her own rationalization.

The Enron story is far from over because Ken Lay has yet to go on trial.

One of the classic children fables on this phenomenon is The Emperor's Clothes

Everyone remembers the little sweet innocent child who finally points out that the adults around him/her are swimming in a sea of delusion.

Who remembers though how the grown ups got there?

The ploy that the thought spinners spun was based on vanity and greed. Only those who are wise and friends of the Emperor can see the delicate and complex fabrics. Remember?

Once you accept that lie, if you appear in front of the Emperor and think you are seeing something else, you better lie. Otherwise you might die ... for not being a friend of the Sultan ... err I mean Emperor.

Anonymous said...

Why would Saudi Arabia exaggerate the amount of their reserves? If they said that they had reached their peak, the price of oil might go to $100 per barrel very quickly. Why lie and only get $60 per barrel?

Kurt Cobb said...

Anonymous asks why the Saudis would exaggerate their reserves when not doing so would likely drive up the price of oil considerably and make them a lot more money. I think there are two reasons, one financial and one political and military. The financial reason is one that Saudis know only too well from the previous oil spikes in the 1970s. Spikes lead to demand destruction, increased exploration for oil and the development of alternative energy sources. The Saudis must believe that they still have a chance to prevent all of these developments which they calculate could lead to a second oil slump.

The political and military reason has to do with the U. S. - Saudi connection. The United States has long been the military and political protector of the Saudi royal family. In exchange for this protection, the Saudis have agreed to moderate oil prices and keep supplies flowing. In the hierarchy of priorities, political survival rates higher than profit. That's why the Saudis continue to do the bidding of the United States.

But, can the Saudis continue to be the world's swing producer and thereby moderate prices at will? And, is the United States still capable of protecting the Saudi regime? These two questions no longer have definitive answers. I believe that is why the Saudis are so nervous.

step back said...

It's not always as simple as a single actor and a single lie. Remember, the US CIA told the Bush admin what the CIA thought the admin wanted to hear --yes there are WMDs, tons of them, under the ground, we will easily dig them all up