For your Sunday amusement:
Myth of Spare Capacity
Setting the Stage for Another Oil Shock
C.J.Campbell, Petroplan Inc.
from the Oil and Gas Journal, March 20, 2000
The fundamental driver of the 20th Century's economic prosperity has been an abundant supply
of cheap oil. At first, it came largely from the United States as it opened up its great territories
with dynamic capitalism and technological prowess. But its discovery peaked around 1930, and
inevitably led to a corresponding peak in production some forty years later. The focus of supply
shifted to the Middle East, as its vast resources were tapped by the international companies. They
however soon lost their control in a series of expropriations as the host governments sought a
greater share of the proceeds. In 1973, some Middle East governments used their control of oil
as a weapon in their conflict with Israel, giving rise to the First Oil Shock that rocked the world.
The international companies had however largely anticipated these pressures, and before the
shock had successfully diversified their supply from new productive provinces in Alaska, the
North Sea, Africa and elsewhere. These deposits were more difficult and costly to exploit, but
production was rapidly stepped up when control of the traditional sources was lost. In part that
was made possible by great technological advances in everything from seismic surveys to drilling.
Geochemistry and better geological understanding made it possible to identify the productive
trends, once the essential data had been gathered.
The industry found and produced the expensive and difficult oil from the new provinces at the
maximum rate possible, leaving the control of the abundant, cheap and easy oil in the hands of the
Middle East OPEC countries. The latter were accordingly forced into a swing role, making up the
difference between world demand and what the other countries could produce. It should surprise
no one that such an arrangement led to price volatility.
But these new provinces faced the same depletion pattern as had already been demonstrated in
the United States. The larger fields, which are found and exploited first, gave a natural discovery
peak. Advances in technology and operating efficiency also reduced the time-lag from discovery
to the corresponding production peaks. Whereas it took the United States forty years, the North
Sea, which is now at peak, did it in only twenty-six.
As discovery in accessible areas dwindled to about one-quarter of consumption, the industry,
which fully appreciated this obvious link between discovery and production, turned its attention to
the last remaining frontier, namely the deepwater. It is also subject to depletion with an even
shorter time-lag between the peaks of discovery and production. Although much of the ocean is
deep, only a few areas have the essential geology, giving a potential of not more than about 85
Gb (billion barrels) - enough to supply the world for less than four years. It is no panacea.
A combination of circumstances led to a dramatic fall in the price of oil in 1998. They included
unseasonably warm weather; an Asian recession that reduced the demand for swing Middle East
production; the collapse of the ruble, encouraging exports; and further turns in the UN-Iraq
imbroglio. The market itself, which now included hedge funds and derivative merchants, had no
alternative but to over-react because of its transparent short-term nature. The major companies,
plainly seeing that exploration could not underpin their future, took the opportunity of the price
crisis to merge, successfully concealing their real predicament from the stockmarket. Budgets
were slashed, and a climate of uncertainty led to an improvident draw on stocks. Everyone hung
on the pronouncements of OPEC, imagining that it held the key.
Norway and Mexico offered to cut production to help support price. The OPEC countries
themselves did everything possible to foster the notion that they could flood the world with cheap
oil at the flick of a switch. It was a strategy aimed to inhibit investments in gas, non-conventional
oil, renewable energy or energy saving that they feared might undermine the market for their oil,
on which they utterly depend.
But it was a short-lived crisis, and before long the underlying resource and depletion pressures
manifested themselves. Now, prices have rebounded with a staggering 300% increase in twelve
months. Many of the famous oil analysts, who were predicting that oil prices would stay low
forever, are changing their chameleon skins, as they watch prices soar through $30/b and break
the chartists' barriers. With baited breath, they hang on the next word from OPEC. The US
Secretary of Energy travels the world speaking of diversity of supply as he talks in vain to
countries with little to offer in the face of depletion. Norway's role as the world's second largest
exporter is critical, but it transpires that not a single well was closed by government edict. It is
easy for the Norwegians to support price as they watch their old giant fields fall off plateau
despite every heroic effort. Mexico has now confessed to the previous exaggeration of its
reserves, which in 1999 fell, following an external audit, from 49 Gb to a more realistic 28 Gb,.
Meanwhile it is forced to undertake a mammoth nitrogen injection scheme to try to pump up the
ageing Cantarell Field. It does not sound as if the Mexicans have much option but to watch their
production fall.
The Middle East fields too are getting old, and in some cases, very old. Development drilling has
continued unabated despite the fall in production. Venezuela's new production comes largely from
infill drilling in old heavy oil fields, which is dependent on the amount of effort and investment. It
does not sound as if it has many shut-in wells either. Its oilmen now speak of reduced capacity.
Logic suggests a future something like this:
OPEC makes some conciliatory noises about raising quotas in response to US pressure,
wishing to maintain the illusion that its members can meet demand at will.
Norway and Mexico continue to support OPEC within the framework of such conciliatory
words, making a virtue of necessity.
The market takes the hint and marks down the price of oil in an action that feeds on itself
as the new flavour of the month permeates the ranks of speculators, hedge funds and
derivative specialists searching for a quick buck. Refiners hold back from filling their tanks.
Prices collapse to the low $20's, even perhaps plummeting briefly into the 'teens. People
relax in the belief that the wolf has headed back into the forests. The famous flat-earth
economists again cheer that market forces reign supreme.
But then a few weeks later, people begin to notice that fewer tankers are arriving. Norway
says that storms have had an impact; Venezuela speaks of floods; Mexico claims
restructuring; Saddam says he needs a spare part ; King Fahd leads a delegation of
puzzled Senators into the desert to show that all the wells are fully open.
The penny finally drops that there is no instant spare capacity in the sense of shut-in wells.
The men at their screens start marking up prices.
A new upward momentum drives prices through the $40 barrier. When Air Force One
makes a new panic tour to Norway, Mexico and the Middle East, it meets ashen faced
oilmen saying that they have been working night and day to meet their quotas, but were
unable to do so.
The world, including OPEC, gradually appreciates that it faces a losing battle in trying to
offset the depletion of the large, old, low-cost fields.
Of course, the Middle East can raise its production, since its depletion rate is so low, but it will be
a long haul to bring in the ever smaller fields, which are all that remain, and exploit small
extensions and secondary reservoirs in known fields. It is not a matter of simply opening a valve.
Middle East share of the world's supply of conventional oil was 38% in 1973 at the time of the
First Oil Shock, but had fallen to 18% by 1985 as the new provinces flooded the world with flush
production from giant fields. It is now about 30%. Unlike in the 1970s, this time it is set to
continue to rise as, there are no new major provinces in sight. Share will likely reach 35% by
2002 and 50% by 2009. By then, the Middle East too will be close to its depletion midpoint, and
unable to sustain production much longer irrespective of investment or desire.
It will be a hot summer. Strident politicians will accuse the oil companies or the Muslims of
gouging the consumer, their minds having been further concentrated by a related collapse of an
already grossly overheated stockmarket. No doubt, there will be calls to send in the Marines. But
it is an election year, and the Presidential candidates will relish the agony of the dying days of the
old administration. Democratic politicians cannot in practice plan for the future, but they can
certainly win votes by reacting to crises. So, the hope is that the new President will look reality in
the face and tell the people what he saw. If he does so, he will explain that we are not about to
run out of oil, but that conventional oil will peak around 2005 and all oil, five years later. Once the
people realise that they are not being gouged by anyone, they will face up to their predicament
with courage and fortitude. They will be surprised at the number of solutions, some improving the
quality of life, but finding oil that is not there to be found will not be one of them.
2000 March 7 |
