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:

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