Web note: Mr. Cooke has graciously offered to include Chapter 2 of his book, Oil Jihad and Destiny. Energy, and more specifically oil, is one of the most crucial topics for this new century. Mr. Cooke was interviewed as a guest expert on Financial Sense Newshour. It's a great interview and a good read. Interview  Book Information

Oil Depletion Forecasts

Interest in the subject of oil depletion has been growing. Here is a representative synopsis of current opinion.

Douglas-Westwood

Douglas-Westwood, Ltd. is a respected oil industry consulting firm based in Canterbury, England According to Douglas-Westwood's 3rd edition of “The World Oil Supply Report 2004-2050”, authored by Dr Michael R. Smith, three fundamentals are strongly evident: increasing oil demand, reducing reserves and a decline in discovery rates[1].

"Global oil demand grew by a dramatic 2.6% in 2003 with the greatest increase from China. This was led by a surge in oil-fired power generation capacity and a 75% jump in sales of passenger vehicles. Although the 2003 demand growth of over 10% in China is unsustainable, it is still expected to remain the highest in the world." … 

"The world is drawing down its oil reserves at an unprecedented rate. Although 99 countries have or can produce significant oil, 52, including the USA, are already well past peak (greater than 5 years) whilst another 16 including the UK, Norway, Australia and China are at peak or will reach it soon. All the remainder will see peaks in the next 25 years."…

"Only Russia, Kazakhstan and Azerbaijan can truly lay claim to significant conventional oil reserves and projects here have been very slow to get off the ground. And although deep waters are a great opportunity, they are currently responsible for only around 4% of production and are expected to only reach 10% of total capacity."…

 “Thus the fundamental conclusions remain that the world’s known and estimated yet-to-find reserves and resources cannot satisfy even the present level of production beyond 2020. And just 1% growth in global economic activity increases demand such that a production peak occurs as early as 2016. Although the response will be complex, this will ultimately result in a sustained increase in oil prices."…

"A short period of over-supply is forecast, generated by growth from the former Soviet Union and from deepwater (production) … However, by 2008 all OPEC countries will need to begin to increase production as much as they can to meet even modest demand growth. Iraq is probably the most under-explored country in the world in relation to its productive potential. Once stability is achieved a field development programme must begin with very large infrastructure projects and huge investments. However, whether companies will be willing to take on the political and geological risk, remains to be seen,” .

The report stresses the need for rapid action by consuming nations.  “All governments must review energy supply security now to produce policies and budgets consistent with impending shortfalls in oil supply in the coming years. Japan and China are competing for Russian oil whilst a number of countries in Western Europe are already facing up to the prospect of energy supply shortfalls and beginning major programmes to encourage renewables. However, Europe, Asia and North America will need a lot more than renewable energy to overcome the long term supply squeeze."

USGS
U.S. Department of the Interior, U.S. Geological Survey
From: USGS World Petroleum Assessment 2000.

"The USGS periodically estimates the amount of oil and gas remaining to be found, and since 1981, the last three of these studies has shown a slight increase in the combined volume of identified reserves and undiscovered resources.

In USGS World Petroleum Assessment 2000, the world was divided into approximately one thousand petroleum provinces, based primarily on geologic factors, and then grouped into eight regions roughly comparable to the eight economic regions defined by the U.S. State Department. Significant petroleum resources are known to exist in 406 of the 1000 geologic provinces.

The U.S. Geological Survey's latest assessment of undiscovered oil and gas resources of the world reports an increase in global energy resources, with a 20 percent increase in undiscovered oil and a slight decrease in undiscovered natural gas. This assessment estimates the volume of oil and gas, exclusive of the U.S., that may be added to the world's reserves in the next 30 years."

"There is still an abundance of oil and gas in the world," said Thomas Ahlbrandt, USGS World Petroleum Assessment project chief. "Since oil became a major energy source about 100 years ago, about 539 billion barrels of oil have been produced outside of the U.S. We now estimate the total amount of future technically recoverable oil, outside the U.S., to be about 2120 billion barrels."

" … The USGS team believes the largest reserves of undiscovered oil lie in existing fields in the Middle East, the northeast Greenland Shelf, the western Siberian and Caspian areas, and the Niger and Congo delta areas of Africa. Significant new reserves were found in northeast Greenland and offshore Suriname, both of which have no history of production. 'What we did is look into the future and predict how much will be discovered in the next 30 years based on the geology of how it gets trapped,' explains Suzanne D. Weedman, program coordinator of the USGS World Petroleum Assessment 2000. 'We also believe that the [oil] reserve numbers are going to increase.' the USGS report is documented with 32,000 pages of data." 

The USGS conventional oil reserve numbers would appear to break down as follows:

If we correct the USGS Known Reserves data for production since 1995, Total World Resources of conventional oil and NGL as of 12/31/20 03 would appear to be 2.047 Bbl (billion barrels).

EIA
Energy Information Administration[2]
From: International Energy Outlook 2003 (IEO2003)
(Italics were inserted by the author for emphasis).

"Worldwide consumption of commercial energy is projected to grow by 58 % over the next two and one-half decades … (with)  much of the growth to occur in the developing world …

In the IEO2003 reference case projection, world oil consumption increases from 77 mm bpd in 2001 to 119 mm bpd in 2025, an annualized growth rate of 1.8 %.

The increases in worldwide oil use projected in the reference case would require an increase of 42 mm bpd over current productive capacity. OPEC producers are expected to be the major source of increased production, but non-OPEC supply is expected to remain competitive, with major growth in offshore resources, especially in the Caspian Basin, Latin America, and deepwater West Africa. …"

From: Annual Energy Outlook 2003

"As has been typical over the past few years, energy prices were extremely volatile during 2002. Spot natural gas prices, about $2 per thousand cubic feet in January, rose to between $3 and $4 per thousand cubic feet by the fall. Average wellhead prices, which are moderated by the inclusion of natural gas bought under contract, also increased over the year. Crude oil prices also rose in 2002, mainly because of reduced production by the Organization of Petroleum Exporting Counties (OPEC) and, to a lesser degree, fears about the potential impact of military action in Iraq. Crude oil prices began 2002 at roughly $16 per barrel and were between $25 and $30 per barrel by the fall. …

Net imports accounted for 55 percent of total U.S. oil demand in 2001, up from 37 percent in 1980 and 42 percent in 1990. That trend is expected to continue. A growing portion of imports is projected to be refined petroleum products, such as gasoline, diesel fuel, and jet fuel, assuming the future availability of those products in world markets. …

In nominal dollars, the average world oil price is expected to reach approximately $48 per barrel in 2025. 

World oil demand is projected to increase from 76.0 million barrels per day in 2001 to 112.0 million barrels per day in 2020 including projected demand in the former Soviet Union and in developing nations, including China, India, Africa, and South and Central America. World oil demand, including both conventional and unconventional oil supplies, grows to 123.2 million barrels per day by 2025. Growth in oil production in both OPEC and non-OPEC nations leads to relatively slow growth in prices through 2025. OPEC conventional oil production is expected to reach 60.1 million barrels per day in 2025, more than double the 28.3 million barrels per day produced in 2001. The forecast assumes that sufficient capital will be available to expand production capacity.

Non-OPEC conventional oil production is expected to increase from 45.5 to 58.8 million barrels per day between 2001 and 2025. A 1.0 million barrel per day decline in production in the industrialized nations (United States, Canada, Mexico, Western Europe, Japan, Australia, and New Zealand) is more than offset by increased production from Russia, the Caspian Basin, Non-OPEC Africa, and South and Central America (in particular, Brazil). Russian oil production is expected to continue to recover from the lows of the 1990s and to reach 10.4 million barrels per day by 2025, 44 percent above 2001 levels. Production from the Caspian Basin is expected to exceed 5.0 million barrels per day by 2025, compared with 1.6 million barrels per day in 2001. By 2025, projected production from South and Central America reaches 6.3 million barrels per day, up from 3.7 million barrels per day in 2001. Non-OPEC African production is projected to grow from 2.7 million barrels per day in 2001 to 6.9 million barrels per day by 2025. …

USA Total energy consumption is projected to an average annual increase of 1.5 percent. Light-duty vehicle miles traveled are projected to grow by 2.4 percent per year through 2020 and by 2.3 percent per year through 2025. Consistent with recent trends, less improvement is projected for the average fuel efficiency of new light-duty vehicles than in AEO2002. New light-duty vehicle efficiency is projected to reach 25.6 miles per gallon by 2020 in AEO2003  …  and 26.1 miles per gallon by 2025.

USA Total petroleum demand is projected to grow at an average annual rate of 1.7 percent through 2025 (reaching 29.17 million barrels per day), led by growth in the transportation sector, which is expected to account for about 74 percent of petroleum demand in 2025. … "

IEA
International Energy Agency[3]
From: Oil Supply Prospects
(Italics were inserted by the author for emphasis).

"Oil reserve estimates are inevitably uncertain and studies normally report oil reserve estimates as ranges, rather than as point estimates. For example the United States Geological Survey in 1993 reported a range of 2.1 to 2.8 trillion (1012) barrels for worldwide recoverable reserves of conventional oil. Experts differ on these figures; some take a static view, emphasizing geological and statistical issues that lead to a low reserve estimate, and some take a dynamic view, arguing that rapidly advancing technology will help discover more reserves and make a wider range of already known deposits economically recoverable. Experience in mature oil regions indicates that production builds to a peak when approximately half of the ultimately recoverable reserves has been produced, and then falls away. The application of new technologies, such as horizontal drilling and 3D seismic analysis, determines the ultimate size of recoverable reserves. It can extend the peak and delay or slow the decline in production. But eventually production falls, given a fixed oil resource. This has been the experience, for example, in the United States.

This approach has been applied on a regional basis. It indicates that a peaking of conventional oil production could occur between years 2010 and 2020, depending on assumptions for the level of reserves. Oil production outside OPEC Middle East would peak before OPEC Middle East production implying a greater reliance on OPEC Middle East supply between the two peaks. A plateau in oil production for OPEC Middle East of 47.9 Mbl/day has been assumed, rather than a sharp peak, following an IEA study.

… projections for oil production profiles for the world … (assume) ultimate recoverable reserves of conventional oil of 2.3 trillion barrels. … Table 1 gives details of supplies for conventional and non-conventional oil. The transition from conventional to non-conventional oil as the marginal supply in 2015 is assumed to raise the oil price from $17-25 … over the period 2010 to 2015. The use of non-conventional oil expands rapidly after 2015 as it meets the increase in demand for liquid fuels and compensates for the decline in conventional oil production.

….  To produce large and increasing volumes of oil from non-conventional sources will require many major multi-billion dollar projects. Some unevenness in supply availability is possible because of the long lead times required for these big projects and the difficulties in matching supply to demand … . It is necessary to distinguish fluctuations in the world oil price from its longer term average level. Some short-term price movements could well arise from supply-demand mismatches, … But opinion on the effect of this changeover on …  oil price is mixed."

"A higher view of oil reserves would assume an ultimate stock of recoverable conventional oil of 3 trillion barrels, compared with the lower assumption of 2.3 trillion barrels…. This view postpones the production peak of conventional oil and the associated rise in world oil price to 2020."

Table 1
IEA Oil Supply 1996-2020*

*Assuming a Lower Estimate of Conventional Oil Reserves of 2.3 trillion barrels

To its credit, the IEA does present us with a relatively unambiguous analysis of its  data. The stark truth comes out if we are willing to analyze the implications of the IEA's report.

The IEA apparently believes that conventional crude oil shortages are inevitable. In order to provide the world with enough energy, non-conventional fuel production will have to increase rapidly after 2014.  According to the above Table, by 2020, we humans will have to be producing 17.3 Mbl of un-conventional petroleum liquids per day ( 6.3 Bbl per year ). The IEA has illustrated this shift in the source of oil production in the following chart. This chart also shows two other important points: non-OPEC oil production has already peaked, and OPEC oil production will peak about 2014 - 2018.

It's all downhill from there.

Figure 1
IEA: Oil Supply Profiles 1996-2030

Independent Analysts

Colin Campbell
October 23. 2002. Professor Colin Campbell, a senior oil geologist and oil executive with forty years of experience in oil exploration and production was interviewed by "From The Wilderness" Editor Mike Ruppert. The complete text can be found at WEB site fromthewilderness.com/free/ww3/102302_campbell.html.

"The key event in the Petroleum Era is not when the oil runs out, but when oil production peaks, especially as demand and population are rising. World per capita oil production peaked in 1979 and has been in decline since. The peak in volume of total world oil production is upon us right now, even as the demand or better said -- the need -- for oil is increasing rapidly.

Several things are a given. First the total remaining conventional oil on the planet is estimated to be around 1 trillion barrels. Second, at present rates (not those of five or 10 years from now), the world is using close to 80 million barrels per day. At the current rate, there would be only enough oil to sustain the planet for another 35 years under the best of scenarios. But the oil that remains is going to be increasingly expensive to produce and it will tend to be of a lesser quality, necessitating higher refining costs, than what has already been used. All of those costs will have to be passed on in the form of price hikes or -- in some cases -- spikes. Oil price spikes invariably lead to recession. The world's economy is based upon the sale of products that are either made from oil or which need hydrocarbon energy (including natural gas) to operate, either via internal combustion or via electricity.

Different regions of the world peak in oil production at different times. The U.S. peaked in the early-1970s. Europe, Russia and the North Sea have also peaked.

The majors are merging and downsizing and outsourcing and not investing in new refineries because they know full well that production is set to decline and that the exploration opportunities are getting less and less. …

Only a fraction of the oil in the reservoir is recoverable because it does not sit in one big cavern down there but in the very small pore spaces between the grains of sand. These grains are coated in water and when it coalesces, it blocks the pore spaces preventing the further movement of oil. … It is said that recovery has increased from 30 percent to 40 percent thanks to technology and is set to rise …in the future. But most of this improvement has nothing to do with technology. It is an artifact of reporting. The industry has always made conservative initial estimates …so reserves naturally grow over time."

Duncan and Youngquist.
Richard C. Duncan and Walter Youngquist, “Encircling the Peak of World Oil Production,” Natural Resources Research, (1999):3:219-232, p. 220.

“Oil has formed in the upper approximately 16,000 ft of the Earth’s crust since at least as far back as the Cambrian Period, some 550 million years ago …. It is a rich inheritance of highly concentrated solar-derived energy captured by myriad organisms, chiefly algae, and then distilled by geological processes into an energy form that is unequalled by any other energy source in its versatility and convenience in handling. Now, within one human lifetime, one-half of this unique 550 Million Year inheritance will have been spent. The remainder will go very fast.” The article predicts that by 2007 the world will peak in oil production at 30 billion barrels per year and by 2020 we will have dropped to 24.6 billion barrels per year.

James Puplava.
From an excellent document prepared by James J. Puplava, Part 1: Hubbert's Peak & The Economics of Oil; available on Financial Sense, March 16, 2002; financialsense.com.

"Hubbert estimated world oil reserves at 1.8 trillion barrels. Since that time and including new discoveries, the estimate has been raised to 2.0 to 2.1 trillion barrels of oil. We now have data on world oil production going back to 1850. Colin J. Campbell of Petroconsultants has made a country-by-country estimate of the world’s oil reserves. His estimates match those of Hubbert at 1.8 trillion barrels. With updated data, there has been no significant bulge or dip in the world's production curve as originally estimated by Hubbert. Using production decline curves from known oil reserves, petroleum analysts using Hubbert’s methods have now been able to estimate the peak in world oil production. According to these estimates, world oil production will begin to peak between the years of 2004 and 2008. A few of the top geologists, including Colin J. Campbell, think that peak is in 2003. The point to understand is that we are depleting our oil reserves at an annual rate of 6% a year; while demand growth is growing at an annual rate of 2%. In order to simply keep even, the world’s oil industry would have to find the equivalent of 8% a year of new oil reserves from new discoveries. This is not happening. The world consumes 76 million barrels of oil a day. This oil is not being replaced.

There is nothing going on in the Caspian Sea, West Africa, or the South China Sea that would come close to replacing what we are now consuming.

Political leaders and the public are totally oblivious to this fact. They are not paying attention. Last year's energy crisis has now been forgotten. The news media explained the crisis in terms of industry price gouging, regulations, taxes, and distribution problems. No one is paying attention to world production declines in the U.S. or elsewhere. This means there is nothing that can be done now in order to avoid a future crisis. It takes years from the time of discovery of new oil to the time it is produced, shipped, and refined and consumed as energy. The oil that is discovered today won’t reach the markets for another 8-10 years. An unprecedented crisis is just over the horizon because of inattention and neglect."

Confusion And Reality

It should be obvious that both the USGS and the Department of Energy are under pressure to make sure their respective projections of oil consumption are matched by oil production and reserve availability. Publishing data that shows oil production will be less than oil demand would not be politically correct.

Critics of the USGS World Petroleum Assessment 2000 point out that this survey relies heavily on statistical analysis. The USGS has assumed that if certain types of geological formations in one part of the world have yielded deposits of oil in the past, then it follows that oil deposits will be equally abundant in these formations where they appear in other parts of the world. The USGS has thus identified the formations where oil is likely to be found. These geological structures are well known. Unfortunately, the USGS has determined its reserve estimates by making probability calculations, rather than by drilling holes in the ground. Whether there is, or is not, any oil in these structures is therefore speculative. The USGS also comes under fire for its oil recovery assumptions, which appear to be 30 to 33 percent higher than current oil production experience.

The IEA and the U. S. EIA/DOE appear to rely on statistics published by various trade publications, most notably the "Oil and Gas Journal" and "World Oil".  These statistics are, in turn, heavily influenced by the politically motivated reserve claims of the oil producing nations. The reserves routinely quoted by the member nations of OPEC, for example, are highly suspect because even to casual observation it is obvious they have been manipulated.

There is a high level of confusion over the classification of oil reserves. For example, what is the difference between "identified reserves" and "proven reserves"?  If proven reserves of 859 Bbl of oil are defined to include all Identified reserves, then total available reserves of conventional oil increase to 1.1 Tbl (Trillion barrels of oil). Total available reserves, including oil that may be found in deposits under the ocean, oil from tar sands and shales, oil that is located under layers of polar ice and oil derived from petroleum liquids, may exceed 3 trillion barrels. That would appear to give us some breathing room in our oil depletion scenario.

But wait a moment. If we accept these most optimistic estimates of oil reserves, is it likely that we will be able to find all of them?

No.  Logic infers that a percentage of possible oil reserves will never be found because they exist in formations that are inaccessible - under the ocean, under layers of ice, or in lands plagued by bad weather and hostile cultures.

Can we assume that all found "pools" will be large enough to be of practical value?

No.  The cost of extraction will exceed the value of found oil in some percentage of reserves. All reserves are not equally useful. Most of the oil found over the last four years, for example, has come from smaller deposits that will deplete rapidly.

Can we assume that we will be able to extract every drop of oil from all available reserves?

No.  Although available technology has dramatically increased the volume of oil that can be recovered, all wells have a finite life span. When abandoned, there will still be oil in the ground.

Can we assume, as some have claimed, that oil from tar sands and shales will replace the declining volume of conventional oil production?

No.  Heavy oil must be "thinned" by the addition of condensates (Pentane, for example) in order to manufacture a feedstock that can be refined into petroleum products. Existing supplies of these dilutents are limited. In addition, heavy oil production uses increasingly scarce natural gas to heat the oil so that it will flow from its source rock. Natural gas shortages will curtail production.

How realistic is the EIA assumption that OPEC suppliers will be able to increase conventional oil production from 28.3 million barrels per day in 2001, to 60.1 million barrels per day in 2025?

Given the realities of Middle East politics and projected oil production capacity, this assumption is highly speculative.

How realistic is the IEA assumption that non-conventional liquids production can increase fast enough to make up the difference between increasing demand and declining conventional oil production?

If we humans immediately adopt the recommendations found in this report, it is possible that we can grow our non-conventional liquids production fast enough to compensate for declining conventional oil production. Unfortunately, it is highly unlikely that existing alternative energy programs will be available for mass commercialization before we encounter a depletion crisis.

From the 2003 Update of the ASPO (Association for the Study of Peak Oil) Oil & Gas Depletion Model (Colin Campbell & Anders Sivertsson).

"We are using oil faster than we are finding it and have done so since about 1981. … Although there remain the eternal uncertainties about the reliability of the data, it appears that the world's oil account has been running a deficit since 1981, as it continues to eat into its inheritance from past discovery."

And consider Colin Campbell's base case for ASPO: "Total world conventional petroleum production from day one to year 2075 (including already produced and yet to be discovered) is estimated at about 1,900 billion barrels, and unconventional oil production (includes natural gas liquids, bitumen, deepwater, arctic, etc.) increases this total to about 2,700 billion barrels. Oil production from all sources is expected to rise to about 83 million barrels per day in year 2010 and then begin a terminal decline."

Going forward, oil companies are going to be under increasing pressure from government agencies to be sure they have accurately stated their estimated reserves. For example:

Thursday, March 18, 2004, AP Biz Wire, seattlepi.nwsource.com

"The Royal Dutch/Shell Group of Cos. … announced additional cuts to its estimated reserves of oil and natural gas and suggested that more reductions might follow. … Shell has now reclassified 4.15 billion in reserves that it had carried on its books."   Reserves under contract are carried as an asset on the company's books.

Market Trends

The Peak

Disaster prophets like to point out that once oil production peaks, it will then decline at a rate that is equal to, or greater than, the rate of increase experienced when there was a surplus of reserves. This is the very sharp "peak" of oil production so often seen in various articles on oil depletion. If geology and the mechanics of extraction were the only variables, this would probably be the case.  A sharp peak would occur and we would subsequently feel as though the availability of oil were falling off a cliff because of a rapidly growing delta between real demand and available production. However, since neither production nor consumption have historically followed a smooth curve - up or down - and since there is an economic interaction between demand, consumption and production, we should expect the peak of consumption to be characterized by a series of alternating cycles.  Periods of shortage will be separated by periods of surplus. Shortages will curtail economic activity. As oil production recovers from a shortage, it will become available to a market where demand has been decreased by the recessionary influence of the previous shortage.  Surplus oil decreases prices. Economic theory suggests that the combination of lower prices and surplus oil should stimulate demand - assuming, of course,  there are no peripheral events to limit an economic recovery. The recovery will continue until increasing oil demand again exceeds production. At this point, consumption should equal production, plus or minus variables such as available storage, weather conditions, transportation snafus, rank speculation, cultural conflict, labor strikes, political conflict, and so on. If thereafter production should decrease, for any reason, consumption will also be forced down. Decreased oil consumption, along with the associated increases in petroleum prices, will cause a corresponding decrease in economic activity. The cycle will thus be repeated.

We must conclude, therefore, that oil induced recessions, punctuated by periods of increased economic activity, become a distinct possibility as oil production peaks. These cycles could become very severe in magnitude, and the cultural challenges discussed elsewhere in this report will certainly serve to exacerbate their volatility. These cycles may have already begun. We shall certainly see their impact well before 2010.

Real Versus Natural Demand

Boring as economics may be to some readers, it is very important for us to understand that at the "peak" of oil production, and beyond, there will be a growing divide between demand, consumption and production. Indeed, demand will split into to components: Natural Demand and Real Demand.

Natural demand quantifies the theoretical demand for oil that would exist if there were no impediments to consumption. China, for example, currently has a projected average annual natural demand of 3.6 percent per year. That is how fast China's natural demand for oil would grow each year (on average) if there were no restrictions on consumption or economic growth for the period 2003 through 2022.  Natural demand is not merely a theoretical number. It reflects the economic and cultural expectations of a consuming nation. If oil production fails to keep up with natural demand, then there will be social discontent because consumers have to reduce their expectations. Oil shortages will restrict consumption as we approach the peak of oil production.  Consumer confidence will subsequently decline, and this decline may trigger a recessionary trend in the national economy.

Real demand, by contrast, measures how the demand for oil ebbs and flows according to changes in price and the economic health of consumer nations. Growing economies and lower prices stimulate additional demand. Recessionary economies and higher prices reduce demand. As we approach the peak of oil production, cycles of shortage and surplus will increase the volatility of real demand. During shortages, consumers will be compelled to reduce their demand to match the actual availability of oil - as happened in 1973. Real demand will be forced down until consumption equals production. But what happens when there is a subsequent surplus? The growth of real demand will be constrained by the health (or lack thereof) of the economy. In up cycles, we can expect real demand to trail available oil production until the economy recovers. Thus we can expect economic down cycles caused by oil shortages and higher prices to happen very fast. The psychological impact will be traumatic. Up cycles based on a surplus of available oil and lower prices will take more time to develop. Consumer confidence will take time to recover.

And so. Why is this discussion important? Because the cycles of consumption and production discussed above will increase the delta between natural demand and real demand. With each passing year, this delta will increase. The larger the delta, the greater the social discontent. Combine the volatile economic hardship of oil shortages with the growing delta between natural and real demand, and it becomes obvious that after oil production peaks, there will be a corresponding increase in social discontent.[4]

The Price of Oil

Pumping Oil

We humans have been lucky. Although the price of oil has been volatile, there has been little upward momentum since 1979. From here, however, oil prices will trend higher.  Sure.  There will be intermittent periods of declining prices. But don't be fooled by temporary illusion. The average year over year price of oil will increase at an accelerating rate throughout our forecast period (2003 - 2022).

Pumping oil from the ground is not like pumping water from a barrel. To recover the oil, it must be encouraged to drain through layers of sand and rock toward the foot of the well. Oil collects in rock formations (the reservoir) where the individual droplets of oil may be trapped in the very small pore spaces between the grains of sand.

Only a fraction of the oil in the reservoir is recoverable. If the grains of sand or shale are coated with water, it frequently coalesces, blocking the pore spaces and preventing the further movement of oil. The lighter the oil (higher API) the more readily it will flow toward the foot of the well and recoveries of 50 to 60 percent are possible over time[5]. Heavier oils will take longer to make this migration and recoveries may be in the 30 to 40 percent range. Enhanced oil recovery encourages this migration through the use of steam, water or gas which are pumped into the reservoir to free up the pore spaces and/or thin out the oil. The resulting increase in production is sometimes referred to as "Reserve Growth", because the original estimate of reserve capacity has been increased through the use of enhanced recovery technology. The productivity of an oil field can be further enhanced by drilling more wells, including horizontal bores that actually traverse the oil bearing strata.

When a new well is proposed, petroleum engineers will estimate how much it will cost to drill the well and how much it will cost to connect that well into an existing oil collection system. Initial production will usually be substantially higher than later production because the well pump is able to capture nearby deposits. Over time, production will decline because of pressure loss, water encroachment, the increasing distance the oil must travel to reach the foot of the well and the depletion of the reservoir. If daily operating expenses are reasonably constant, the cost per barrel pumped to the surface must increase as the volume of recovered oil declines. When the cost of production equals the market value of a barrel of oil, production stops.

The optimists claim that we do not have a depletion problem. New technology such as 3D seismic imaging, directional drilling, "smart" drill bits, improved sensors and so on, will increase the amount of oil we can get from any given well. If new technology will decrease the cost of finding and extracting oil, then there will be a resulting net increase in our reserves. When we move to a new energy system, there will still be oil in the ground.

Glenn R. Morton

"There will always be oil in the ground. There is many times more oil in the ground than we have burned. The problem is that it is too dispersed to be extracted economically. No one is going to spend $10 to get $9 of oil. Occasionally we do that in the oil industry, but I assure you that heads roll at those times. What limits the amount of oil we find is economics and the laws of physics.  …

The oil left in the ground unused can not be moved. Oil is often found in sandstone. It is actually found in the pore spaces between the sand grains. Thus the sand is like a sponge. We can measure the oil saturation and the water saturation of a sandstone reservoir. However, when we pump oil out of the ground, there is an irreducible saturation beyond which the oil won't move. ….

As to finding more oil ….  In the 1960s, people working the North Sea found fields of 1-2 billion barrels each. Today the average field size is around 30 million barrels--almost a 100 fold reduction. (In the Frio trend of Texas 80 years ago, they found billion barrel fields--in the 1990s the average field size found was 4 million barrels). Now, if that 30 million barrel field is far from infrastructure (pipelines), it takes almost as big a platform to produce the 30 million (bl field) as it does to produce a billion barrel field. Lets say that a platform costs $500 million, which isn't far from the truth in some fields. For a billion barrel field that is fifty cents per barrel cost. For a 30 million barrel field it is $16 dollars per barrel. and that is just for the cost of the platform. That doesn't count the cost of running the platform, paying the salaries …, paying the refinery costs, the pipeline costs, the wellhead processing costs, and don't forget royalties …  etc. on top of that.  … "[6]

Matt Simmons

According to Matthew Simmons, an oil industry consultant and investment banker, worldwide Public Exploration and Production companies spent $410 Billion Dollars between 1996 and 1999 to merely maintain a flat production rate of just under 30 Million barrels of oil per day. The Big Five: Exxon, Shell, BP, ChevronTexaco, and Total, spent 150 Billion dollars between 1999 and 2002 to make an almost insignificant gain in production from 16 to 16.6 million barrels per day. Exxon, Shell, BP and ChevronTexaco spent over $40 Billion dollars between the first quarter of 2002 and the first quarter of 2003 on exploration and production. Despite this expenditure, production actually dropped from 14.611 to 14.544 million barrels of oil equivalent per day. "One of the other interesting mantras of the last decade", he said, "was that technology had eliminated dry holes. Well,  we never came close to making the dry hole obsolete. The reason dry holes dropped so much is we drill far less wells. We also stopped doing most genuine exploration."

Price Pressure

So there is no magic spigot that can be turned on whenever we need more oil. Production from existing wells is limited by the laws of physics and chemistry as well as plain old economics. And spending big bucks for exploration may not produce a significant increase in available oil reserves.

In the 1970's, the price for a barrel of oil went from an average of $1.80 in 1970 to $30.03 in 1979. According to economic theory, if production had been elastic, higher prices should have attracted more production, thereby driving down the price. But that did not happen. There was a relatively insignificant increase in production. In fact, the increase in production from 17.8 Bbl in 1970 to 24.5 Bbl in 1979, was just enough to meet increasing consumer demand.  Over a ten year period, a 1,568 percent increase in price only stimulated a 37.6 percent increase in production!   Obviously oil production, excluding unused capacity that may be available in periods of weak demand, is inelastic. The primary producer nations are now able to set the price of a barrel of oil to whatever value they deem prudent. Thus far, that price has been set to maximize the dollar revenue that can be derived from selling an optimum number of barrels of oil. Nations like Saudi Arabia know that if they raise the price too high, consumer nations will fall into an economic decline, thereby reducing the number of barrels of oil that can be sold. So they have usually adjusted the price to provide a maximum return based on a healthy consumer economy.

It is becoming more expensive to find and produce oil. We have not found a really big - and easy to exploit - pool of oil for a number of years. With the exception of the Middle East, and some fields in the southern latitudes, newer discoveries - on land and in shallow water - tend to be on the smaller side. They will be depleted rather quickly and the ratio of production cost to recovered oil is becoming less and less advantageous. As we are forced to look for oil in deep water and polar regions, this cost ratio will become even more expensive. Oil drilling costs versus projected oil recovery make it impractical to drill for oil in smaller deep sea and polar fields. We can only justify recovery operations in the larger finds.

The quality of found oil will decline. Yes. There will be exceptions. But the trend will be toward the production of heavier oils, as well as oils contaminated with chemicals, heavy metals and salt water. Taken together, these factors will increase the cost of refining oil. Not only will the refining process be more difficult, it will also require the addition of more solvents and other chemicals to complete the chemical reaction that "cracks" oil into useful products.

Political volatility will increase the cost of finding, producing and transporting oil. Nigeria, Venezuela and Iraq are current examples of this reality. Future political instability in Iraq and Saudi Arabia will have a critical impact on the price of oil. These challenges will increase the cost of oil leases, disrupt operations and hamper transportation.

It should be clear - the days of relying on "Texas Sweet Crude" or "Saudi sweet" for our oil needs are waning. Exploration, production, and refining operations will become increasingly more expensive.

The price of oil will go up.

Reserves Will Decline

 From the BP Statistical Review of World Energy, June 2002: "Proven oil reserves are growing as new discoveries and increases in recovery rates due to technical advances are outpacing production, but as an annual percentage reserves are not rising as fast as production." In other words, we are using oil faster than we are finding it. In all my months of research, I found nothing of substance which could be used to refute this fact. Aside from short term speculative euphoria that may erupt with the discovery of a new field, there will be a continuing decline in overall average reserves.

Most oil industry insiders will acknowledge that oil is becoming increasingly difficult to find and more costly to exploit.

On April 12, 2002, Fadel Gheit, an analyst at Oppenheimer & Co. commented that oil companies are running out of good drilling prospects[7]. Oil companies are caught between increasing exploration and development costs, increasing production costs and declining exploration results. Rising gas and oil prices have actually masked a general weakness in the industry. J. P. Morgan reported that a lack of growth opportunities would lead to more industry consolidation as companies attempt to shore up their petroleum reserves.

So we have a serious problem. If reserves are not rising as fast as production - a fact backed by industry consensus - it is only a matter of time before production must also inevitably decline.

The issue is no longer - "will production decline".  The key issue and only point of disagreement is "when"?

Derivative Factors

We must recognize that in addition to production and exploration issues, oil exporting countries are now able to control the price for providing us with an increasingly scarce commodity. In other words, the world oil market has transitioned from a market controlled by consumer demand to one controlled by producer capacity. Producer nation motivation and cultural stability has become a factor in determining the availability and price of oil.

Call these the derivative factors of doing business on a global scale. Each poses a potential disruption to the flow of oil. As a result, proven or identified oil reserves are less important than accessible oil reserves - the oil that can actually be produced without disruption. If we want to understand how much oil will be available over the next 20 years, we must consider how these derivative factors are likely to impact oil production and transportation.

Big Oil is painfully aware of the derivative challenge.

For example –

ChevronTexaco
ChevronTexaco.com
Source: 10Q  5/9/2003 Q1

"Upstream. Changes in exploration and production earnings align most closely with industry price levels for crude oil and natural gas. Crude oil and natural gas prices are subject to external factors, over which the company has no control, including product demand connected with global economic conditions, industry inventory levels, weather-related damages and disruptions, competing fuel prices, and the regional supply interruptions that may be caused by military conflicts or political uncertainty. Community unrest has disrupted the company’s production in the past, most recently in Nigeria and Venezuela. The company continues to monitor developments closely in the countries in which it operates. Longer-term trends in earnings for this segment are also a function of a range of factors in addition to price trends, including the company’s ability to find or acquire crude oil and natural gas reserves and efficiently produce them.

During 2002, industry price levels for crude oil trended upward from the $20 per-barrel level at the beginning of the year to about $30 in December and continued rising in the first quarter 2003. Average worldwide industry prices for crude oil and natural gas in the first quarter of 2003 were significantly higher than the same 2002 period and were the major factors in this segment’s higher earnings between periods. In the first quarter 2003, the average spot price for West Texas Intermediate (WTI), a benchmark crude oil, was about $34 per barrel, compared with about $21 in the year-ago period, and peaked at about $37 per barrel in mid-March. … The higher prices for crude oil in early 2003 in part reflected the geopolitical uncertainty in Iraq and Venezuela. …

The company’s equity production was marginally lower in the first quarter of this year as a result of civil disruption late in the period in Nigeria and during most of the quarter in Venezuela. ….

Production was restored in Venezuela before the end of March to levels that were in place prior to the nationwide labor strike. After improved security was in effect in Nigeria, much of the production that had been shut in was restored by mid-April.

The expected production level in 2003 and beyond is uncertain, in part because of production quotas by the Organization of Petroleum Exporting Countries (OPEC) and the potential for local civil unrest and changing geopolitics that could cause production disruptions."

ExxonMobil
exonmobil.com
Source: SEC 10K for 2002
3/26/2003

"The operations and earnings of the corporation and its affiliates throughout the world have been, and may in the future be, affected from time to time in varying degree by political developments and laws and regulations, such as forced divestiture of assets; restrictions on production, imports and exports; price controls; tax increases and retroactive tax claims; expropriation of property; cancellation of contract rights and environmental regulations. Both the likelihood of such occurrences and their overall effect upon the corporation vary greatly from country to country and are not predictable."

Total, S.A.
total.com
Source: Amendment No. 2 to Form F-3
8/6/2003

"A significant portion of our oil and gas production occurs in unstable regions around the world, most significantly Africa, but also the Middle East, South America and the Far East. Approximately 28%, 18%, 9% and 7% of our 2002 production came from these four regions respectively. In recent years, a number of the countries in these regions have experienced varying degrees of one or more of the following: economic instability, civil war, political volatility, violent conflict and social unrest. In sub-Saharan Africa, each of the countries in which we have production has recently suffered at least four out of five of these conditions. The Middle East in general has recently suffered increased political volatility in connection with violent conflict and social unrest. A number of countries in South America where we have production and other facilities, including Argentina and Venezuela, have suffered from economic instability and social unrest and related problems. In the Far East, Indonesia has suffered the majority of these conditions. Any of these conditions alone or in combination could disrupt our operations in any of these regions, causing substantial declines in production. Furthermore, in addition to current production, we are also exploring for and developing new reserves in other regions of the world that are historically characterized by political, social and economic instability, such as the Caspian Sea region where we have a number of large projects currently underway. The occurrence and magnitude of incidents related to economic, social and political instability are unpredictable. It is possible that they could have a material adverse impact on our production and operations in the future. ……

We have significant exploration and production, and in some cases refining, marketing or chemicals operations, in developing countries whose governmental and regulatory framework is subject to unexpected change and where the enforcement of contractual rights is uncertain. In addition, our exploration and production activity in such countries is often done in conjunction with state-owned entities, …  where the state has a significant degree of control. Potential intervention by governments …  can take a wide variety of forms, including:

• the award or denial of exploration and production interests; 

• the imposition of specific drilling obligations;

• price and/or production quota controls;

• nationalization or expropriation of our assets;

• cancellation of our license or contract rights;

• increases in taxes and royalties;

• the establishment of production and export limits;

• the renegotiation of contracts;

• payment delays; and

• currency exchange restrictions.

Imposition of any of these factors by a host government in a developing country where we have substantial operations, including exploration, could cause us to incur material costs or cause our production to decrease, potentially having a material adverse effect on our results of operations, including profits."

Royal Dutch Petroleum Company
Royal Dutch/Shell Group
Source: SEC Form 20-F for the Fiscal Year Ended December 31, 2001

"(Royal Dutch/Shell) Group and associated companies are involved in the exploration for, and production of, crude oil and natural gas operate under a broad range of legislation and regulations that change over time. These laws and rules cover virtually all aspects of exploration and production activities, including matters such as land tenure, entitlement to produced hydrocarbons, production rates, royalties, pricing, environmental protection, social impact, exports, taxes and foreign exchange. The conditions of the leases, licenses and contracts under which oil and gas interests are held vary from country to country. In almost all cases the legal agreements generally have in common that, they are granted by or entered into with a government, government entity or state oil company, and that the exploration risk practically always rests with the oil company. … "

In the section titled "RISK FACTORS 

"The Group and its businesses are subject to various risks relating to changing competitive, economic, political, legal, social, industry, business and financial conditions. These conditions are described below and discussed in greater detail … (in the Annual Report).

Price fluctuations
Oil, natural gas and chemical prices can vary as a result of changes in supply and demand for products, which may be global or limited to specific regions and influenced by factors such as economic conditions, weather conditions or action taken by major oil exporting countries.

Currency fluctuations
The Group is present in more than 140 countries and territories throughout the world and is subject to risks from changes in currency values and exchange controls.

Drilling and production results
The Group’s future oil and gas production is significantly dependent on successful drilling and well development. There are risks in this process in interpretation of geological and engineering data, project delay, cost overruns and technical, fiscal and other conditions.

Reserve estimates
… Oil and gas reserves cannot be measured exactly since estimation of reserves involves subjective judgment and arbitrary determinations and is dependent, amongst other things, on the reliability of technical and economic data.

Loss of market
Group companies are subject to differing economic and financial market conditions in countries and regions throughout the world. There are risks to such markets from political or economic instability, as well as from industry competition.

Environmental risks
Group companies are subject to a number of different environmental laws, regulations and reporting requirements. Costs are incurred for prevention, control, abatement or elimination of releases into the air and water, as well as in the disposal and handling of wastes at operating facilities. Expenditures of a capital nature include both remedial measures on existing plants and integral features of new plants.

Physical risks
The Group’s assets are subject to risk from operational hazards, natural disasters and expropriation of property.

Legislative, fiscal and regulatory developments
The Group’s operations are subject to risk of change in legislation, taxation and regulation. For exploration and production activities, these matters include land tenure, entitlement to produced hydrocarbons, production rates, royalties, pricing, environmental protection, social impact, exports, taxes and foreign exchange."

BP
bp.com
Statistical Review of World Energy, June 2002 

"Concerns about reserve sufficiency are more related to political worries as OPEC and FSU (Former Soviet Union) countries between them control over 80% of proven reserves of (conventional) oil and gas. At end 2001 OPEC had 78% of oil and 45% of gas reserves and FSU had 6% of oil and 36% of gas."

Source: BP Website; 8/19/2003

"Conflict is part of the history of Azerbaijan, Georgia, and Turkey. Each country has suffered periodically from war, unrest and ethnic tension, including in the recent past.

BP’s ethical conduct policy states: 'Before we make major investments in a new area, we will evaluate the likely impact of our presence and activities. These assessments will consider the likely impact of major developments on local communities and indigenous peoples, local infrastructure and the potential for conflict and its implications for security.'

All … companies participating in the projects have considered the risks of future conflict and the means to minimize the potential for conflict. The projects’ sponsors are aware of the emerging literature on business and conflict, particularly on the relationship between extractive industries and conflict. The Regional Review, together with the Environmental and Social Impact Assessments and internal country and project risk assessments, have helped to evaluate the likely impact of their …  activities. …

… In a region where conflict has been prolonged, a number of intergovernmental, bilateral, and non-governmental organizations have developed programs to promote economic and social development. EU, World Bank and NGO initiatives are seeking to promote economic prosperity and integration, build confidence between communities, encourage learning from other conflict resolution processes, and reduce economic and social vulnerability.

While prime responsibility for preventing and resolving violent conflict rests with governments, it is increasingly recognized that business can support positive action by working in partnership, promoting economic growth in which benefits are widely distributed, and influencing conflict through the way in which operations are conducted and through social and community investment. …

In action too, the project sponsors are working to reduce conflict and regional tensions. For example, the projects aspire to contribute to the reduction of tension and conflict potential through positive local engagement. These contributions should be in the form of care for company employees and their families, new investment in community projects, the avoidance of harm to the livelihoods of people living near project facilities and the pipeline route, and transparent, even-handed treatment of land acquisition and other community issues. More generally, the way in which the projects create wealth and employment, and the ways in which they contribute to the protection of human rights, the development of civil society and efforts to combat corruption, are all relevant to conflict prevention and resolution. …"

Bogus Projections

We frequently see statements that existing oil reserves will last for so many years at current rates of consumption. That assumption - "current rates of consumption" is totally bogus. The demand for oil surges and recedes like the waves of the ocean. It is never motionless. Although the market for oil is a growing market (demand is increasing) the pace at which this demand is growing varies according to the economic health of the consuming nations. Further more, if production falters, we are not only concerned with the fact that consumption can not exceed production, we must also consider the delta difference between increasing natural demand and declining production. It is assumed that if there is a surplus of oil production capacity, then real demand could increase as fast as the economies of the consumer nations. Unfortunately, as we near the peak of oil production, oil shortages will force a decrease in consumption and the price of oil will go up. Higher prices and recessionary forces will drive real demand down until oil production recovers.

What does this all mean? It simply means that if you hear someone claim that we have X number of years of oil left at current (rates of) consumption, the statement would be true if:  natural demand (the amount of oil that would be consumed if it were in surplus and available at an affordable price), real demand (natural demand less the impact of higher prices and economic health), consumption (the actual amount of oil that is used), and production (the actual amount of oil that is produced), never change for X number of years. Since there is absolutely no way that will happen, the statement is inherently bogus.

[1]  “The World Oil Supply Report” forecasts likely future oil production for all existing and potential oil producing countries. The report defines the year in which oil supplies will be unable to continue to meet a given global demand.  Unlike many of the world’s publications on oil reserves, this report is not limited by commercial pressures or political needs. The World Oil Supply Report is used by organizations world-wide. Data is drawn from the ‘EnergyFiles’ oil and gas supply information system.

[2]  United States Energy Information Administration, Department of Energy,  www.eia.doe.gov, Provides data on petroleum production, pricing and availability.

[3]  International Energy Agency, www.iea.org, Based in Paris, the IEA is an autonomous agency linked with the Organization for Economic Co-operation and Development (OECD). The IEA produces the annual World Energy Outlook.

[4]  It should be pointed out that as the years go by, natural demand will decline as people adjust to a more austere lifestyle. Never-the-less, there will always be a growing delta between unmet natural demand and a real demand that has been curtailed by oil shortages, higher prices and subsequent economic decline.

[5]  That means 30 to 40 percent of the available oil reserves in a given field can eventually be recovered. For heavier oils, this rate of recovery must inevitably decline to 50 or 60 percent.

[6]  Glenn Morton, is a Geophysicist in charge of reservoir simulation for a major oil company.  Used with permission.