Rising Oil Prices Series: Part IV

Posted by Patrick O'Connor on 6/12/08 10:58 am

This post contains Navellier top-ten energy stock holdings.

This article is the fourth installment of a multi-part series about rising oil prices. In this column, we’ll discuss why supplies might be dwindling. Read parts I, II, and III.

Are crude oil supplies dwindling—and why?

Many industry experts believe that today’s rising oil prices are the result of sharply rising demand—but others argue that demand is not increasing enough to drive prices to the levels we’re currently seeing, meaning that supply must be the issue.

Is it demand—or supply?

As we explained in Part III of this series, we’re currently experiencing a state of disequilibrium in oil prices—and the problem could be supply or demand. But which is it?

In Part III, we talked about demand, however many industry experts argue that supply limitations are the problem. If demand were the problem, they say, higher prices would encourage oil companies to produce more crude oil. In the past few years, global output of crude oil has hovered around 85 million barrels per day despite skyrocketing prices. Something is clearly different—and the most likely culprit is supply.

There are a number of reasons that crude oil supplies could be limited, some geological and some economic. In this column, we’ll examine them.

Crude oil may be peaking, geologically speaking

For decades, geologists have speculated that when half of the world’s original crude oil has been extracted, getting the other half out of the ground will become increasingly difficult or even impossible—a state often referred to as “peak oil.”

In the past, industry experts have argued that the turning point is decades away, since much of the world’s conventional crude oil supplies are untapped; unconventional supplies, such as tar-sand pits, have yet to be fully explored; and constantly improving technologies are allowing us to dig deeper and extract more than ever before.

But now, many of these once-optimistic experts are seeing the glass as half empty. As noted in Part I of this series, in 2000, Sadad I. Al Husseini, former head of exploration and production for Saudi Aramco, the Saudi Arabian state-owned oil company, tallied up some numbers he’d been gathering since the mid-1990s and determined that crude oil output would level off around 2004, plateau for a maximum of 15 years, then begin a gradual but irreversible decline.

We may already be in this period of decline. According to National Geographic, world output from existing fields is falling by as much as 8% a year. That means oil companies must add seven million barrels a day of capacity just to keep pace with current demand—and even more if they’re going to meet growing demand.

Whether you believe we’ve reached peak oil or not, it’s clear that some geological limitations are emerging. The volume of new deposits has fallen each year since the 1960s despite technological advances, such as seismic imaging, which allows an oil company to see deposits deep below the Earth’s surface.

That may be because the world’s largest crude oil fields have already been discovered. Until the 1970s, eight fields producing between 500,000 and one million barrels a day were discovered, according to Matthew Simmons, a veteran oil industry banker. During the 1970s and 1980s, only two were found. Since then, only one has been found: the Kashagan field in Kazakhstan.

At the same time, crude oil output from the world’s largest deposits is declining. Two decades ago, around 12 fields produced more than one million barrels a day. Now only four fields do, including Saudi Arabia’s Gharwa deposit, Mexico’s Cantarell deposit, and Kuwait’s Burgan deposit. And the latter two are already showing signs of declining production. In November 2005, Kuwait Oil Company lowered its estimate of Burgan production from 1.9 million barrels a day to 1.7 million. And from January 2006 though February 2007, Cantarell—the second largest deposit in the world, which reportedly produces one of every 50 barrels of crude oil on the world market—lost one-fifth of its production, with daily output falling from two million barrels to 1.6 million.

That’s a problem, because nearly a quarter of the world’s daily crude oil output comes from the world’s 20 largest fields, according to Wood Mackenzie, a Scotland-based consulting firm. As a result, oil companies are being forced to seek out smaller deposits. But, smaller fields are, well, smaller—and it’s harder to extract crude oil from them. To illustrate, last year’s celebrated discovery of the Tupi deposit—located in the Santos Basin off of Brazil—was called the biggest find in seven years. At an estimated five to eight billion barrels of crude oil, it’s about twice the size of the Roncador deposit, previously Brazil’s largest. But, to put that in perspective, it’s about one-fifteenth of the original estimated size of the Ghawar deposit, which was reported to hold about 120 billion barrels at its discovery in 1948.

As a result, James Mulva, CEO of ConocoPhilips, has said that by 2010 nearly 40 percent of the world’s oil supply will have to come from fields that have not yet been tapped—which are likely to be small. As a result, he and Christophe de Marger, head of French oil giant Total, have predicted that crude oil production will stall at 100 million barrels a day.

Political tensions limit access

Edward Morse, an oil expert who was formerly with the U.S. Department of State and now analyzes the industry for Lehman Brothers, says political obstacles may be more significant than geological issues in dwindling oil supplies. That’s because many of the world’s largest crude oil reserves are located in countries which do not allow foreign investors to find and develop deposits.

For example, Iran, Iraq, and Saudi Arabia are off limits to foreign oil firms. Other countries, such as Mexico, Russia, and Venezuela, will not allow foreign investors access to new fields or the freedom to further develop existing ones. In many cases, that’s hurting their production. According to the International Energy Agency, in the first quarter of 2008 Russian output fell for the first time in a decade. Production averaged about 10 million barrels a day, a 1 percent drop from the first quarter of 2007.

In other cases, political unrest temporarily disrupts supply. For example, crude oil from Nigeria, the world’s tenth largest reserve holder and producer, according to the 2006 Oil and Gas Journal, has declined since February 2006 because of rebel attacks on the country’s oil industry.

OPEC manipulates supply

The Organization of the Petroleum Exporting Countries (OPEC) was founded in 1960 to maintain the price of oil at a level that is beneficial to its members. Today, it consists of 12 countries (plus Indonesia, which is only scheduled to be a member through 2008).

Although OPEC’s ability to control the price of oil has diminished somewhat as oil reserves have been discovered in other countries, OPEC nations still account for around two-thirds of the world’s oil reserves, and 35.6% of the world’s oil production as of March 2008. Moreover, the group reportedly monitors production from other countries, and when these countries increase output, OPEC decreases output accordingly. This undoubtedly gives the organization considerable control over the global oil market—and global economy. During the 1973 oil crisis, for example, the group’s use of oil embargoes allegedly triggered high inflation across the world.

In 2006, OPEC started to reduce crude oil production to stem a fall in oil prices. Less OPEC oil in the market helped fuel a rally in prices, which, according to the law of supply and demand, should have encouraged more production. But it didn’t—in part, say OPEC critics, because the organization is intentionally limiting production to keep prices artificially elevated.

Today, despite a clear rise in demand, as noted in Part III of this series, OPEC has repeatedly refused to increase production. While many nations led by the International Energy Agency have urged the group to pump more oil, it says there is enough in the market, and has declined to do so. Indeed, recent statements by OPEC suggest the group has no plans to review its output until its next scheduled meeting in September 2008.

OPEC claims it is not guilty of price-gouging, and other factors—including a weak U.S. dollar and speculation—are driving up prices. In the next installment of this series, we’ll discuss these issues in more detail.

Navellier Top-Ten Energy Stock Holdings

Vantage Portfolio
Petroleo Brasileiro (PBR); 1-yr Chart; Profile
Sasol Ltd. (SSL); 1-yr Chart; Profile

Power Dividend Portfolio
Noble Energy Inc. (NBL); 1-yr Chart; Profile
Devon Energy Corp. (DVN); 1-yr Chart; Profile
XTO Energy Inc. (XTO); 1-yr Chart; Profile

All Cap Core Portfolio
Occidental Petroleum Corp. (OXY); 1-yr Chart; Profile

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• Comments (1)

Posted by DWD on 6/21/08 4:41 pm

Patrick,

You may have mentioned it earlier in the series, I’m late to the party, but in your 6th paragraph under the “Crude Oil May Be Peaking....” heading, it appears the recent discovery of about 33 billion barrels off the coast of Brazil has been overlooked.

In general, I don’t subscribe to the “peak oil” theory.  Yes, it is a finite resource, but I think data shows we’ve barely scratched the surface, as it were.  Cheap, easy to extract oil, the low hanging fruit, is nearly gone, for sure.  But, as others have noted elsewhere, the world is awash with the stuff.  Thus the only question is one of cost to extract versus what customers are willing to pay, and what alternatives are available.

The argument smacks of late 1800s predictions that, given the rise in population, and that people and goods were transported primarily by horse, by 1950 the US would be 3 ft. deep in horse manure. 

It would seem the prediction only came true in DC.

Regards,

DWD

Regards,

DWD

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