Tuesday, January 08, 2008

Are we running out of oil?

Developments in the oil market in recent years have helped build up a rather pessimistic and widespread perception about the future of oil and the oil industry, which is focused on one common question: Are we running out of oil? The short answer is, "No!" That is the good news.

The bad news is that each additional barrel of high-quality oil to global supply is getting more costly and difficult to find, develop, extract and bring to wherever it is demanded.

If we are not running out of oil, what else should be blamed? Two words: peak oil. The term "peak oil" has begun to enter the common vocabulary thanks to the ongoing, quite heated, debate inside and outside of the oil industry since the turn of the new century. There is no doubt that the debate will continue in the coming years and will probably become part of long-term energy and economic planning.

Challenges facing the oil industry

Our oil-thirsty world is now demanding 86 million barrels of oil every day -- or 1,000 barrels a second. This thirst is expected to increase by about 35 percent by 2030, according to the IEA, EIA and OPEC. To meet that demand will require a net additional supply of more than 1 million barrels per day each year up to 2030. This will certainly not be an easy task when we consider the following challenges facing the oil industry today and in the future:

The inventory of good prospects is diminishing even though some parts of the world have not been thoroughly explored. Since 1986, more conventional oil was produced than were replaced by new discoveries and the peak of discoveries took place in the mid-1960s. The sizes of the newly discovered oilfields are getting smaller and smaller and recent discoveries are replacing only about a quarter of global annual oil production.

Although there are about 47,500 oil fields in the world, about half of the world's oil production comes from less than 120 giant fields, each producing more than 100,000 barrels per day. The majority of the largest giants are over 50 years old and the average size of new giant discoveries is declining.

Offshore supplies have been the main source of growth for world crude production as the onshore supplies have essentially remained at plateau for more than two decades.

World conventional oil production from new oil fields is offset by depletion of oil reserves in known oil provinces. Some of the world's largest oil fields, such as Cantarell in Mexico and Burgan in Kuwait, have already entered the decline phase. And there is widespread speculation that the world's largest oilfield, Ghawar in Saudi Arabia, may be the next to follow. Advanced technology will help reduce the decline, but will not be able to eliminate it.

Supply is getting increasingly dependent on a shrinking number of countries and domestic demand from major exporters is increasing tremendously.

Oil companies are in a global hunt to replace their reserves. Private oil companies (companies that are not owned or controlled by the state) replace their reserves mostly by the discoveries in and near existing discoveries or by merging with others. But the number of companies to be merged is also dwindling. According to a recent Herold/Lovegrove report, the worldwide oil and gas upstream capital spending between 2002 and 2006 more than doubled and so did the acquisition, exploration and development costs. Cambridge Energy Research Associates' (CERA) upstream capital costs index, a measure of project cost inflation, has doubled in the past few years. Besides, skilled labor costs and shortage has already become a real headache.

Over the past decade the number of active rigs drilling in the world more than tripled. They work at or near capacity around the globe. But this has had no parallel effect on boosting production and reserves. The average age of rigs is more than 20 years.

There are immense in-place unconventional oil resources (such as tar sands, extra heavy oil and oil shale) but their fluid quality is poor, recovery rates are lower than that of conventional oil and put pressure on water and, to some extent, natural gas supplies. The liquids derived from coal, natural gas, biomass and seeds are hardly competitive without government subsidies. Moreover, the share of unconventionals in the global oil supply will be determined by a number of fundamental constraints such as costs, environment, investment requirements, energy payback times and, most importantly, energy returned on energy invested in full cycle from well-to-wheel or from seeds-to-wheel. Advances in technology will surely help but how much and how fast remains yet to be seen.

Private oil companies are facing rising competition from national companies both from producing and consuming countries. The competence of many national companies, combined with increasing financial strength, has allowed them to expand rapidly and internationally. As a result, most private companies have started to move into more remote territories, harsher conditions, environmentally more sensitive areas, more complex, large, hard to recover and technologically challenging projects, where the costs and risks are high, including unconventional oil.

As oil prices have increased about 10 fold in the last decade, several countries have restricted access to prospective resources, tightened fiscal terms or revised contract terms. Many of these measures have also been applied in several OECD countries.

These developments have brought about once again the magic question: Has world oil production reached its peak?

Peak oil: a brief background

Peak oil refers to the point at which marginal extraction of conventional oil in an oil field diminishes to zero at about half of its total recoverable reserve, stays at that level for a while and turns negative, marking the decline phase. The first phase of production up to the peak tells us the exploitation of higher quality oil which is easier to access and extract in a relatively cheap way. The second phase, however, will contain rather lower quality oil which is more difficult to reach and extraction that requires the application of artificial pressure lifting techniques in reservoirs.

Similarly, the peak of global oil "production" (extraction) means that as production from old oil fields declines and new discoveries become smaller, more difficult and more costly to extract, the marginal amount of worldwide conventional oil production will diminish to zero for a while and decline thereafter. The point of decline will mark the beginning of the end of the easy oil era.

Arguments like "we are running out of oil" are a misinterpretation of peak oil. Today's average global recovery rate is only about 35 percent. In other words, 65 percent of the world's discovered oil endowment (original oil in place) is left in the ground. Recovery rates may increase in the future but we will never ever be able to recover all the original oil in place. Thus, we will never run out of oil. However, we will run out of is "easy" oil. And that is what indeed peak oil refers to. Some of today's unconventional oil may in the future become conventional and may be categorized as "easy," but they will remain, at least another decade or so, mostly more expensive, polluting and energy intensive to produce and will not probably be in substantial quantities compared to conventional ones.

The peak oil concept was pioneered by a US geologist named M. King Hubbert, who correctly predicted in his seminal speech in 1956 that oil extraction in the lower 48 states of the United States would peak sometime between 1965 and 1970 based on two different ultimate recovery estimates. His estimate for 1970 has been proven to be correct.

According to Hubbert, oil production in any given oil field follows a bell-shaped trajectory over time, with production rising to a maximum and then, when about half the recoverable resource has been extracted, gradually falling to zero. This principle became to be known as Hubbert's Peak and the trajectory, Hubbert Curve. He argued that once discoveries start falling, production would too after a time lag. His essential assumption was that oil exists in fixed, finite and exhaustible quantity; therefore exponential growth in extraction is unsustainable, extraction must eventually decline and cease and total extraction cannot exceed initial quantity.

Peak oil debate

The peak oil debate has created two extreme camps: On the one hand there are those pessimists (mostly geologists) who argue that peak oil is already upon us or shortly (generally before 2015) will be. Once the peak is reached, this camp foresees skyrocketing prices leading to economic ruin, social and environmental collapse, massive dislocation and even a dying civilization. The most important advocate of this group is the International Association of the Study of Peak Oil and Gas (ASPO), promoting the message of imminent depletion, often in crisis tones. Several oil companies such as Total, Statoil, the Libyan National Oil Company, ARCO and ConocoPhillips are closer to the opinions of the pessimists.

On the other hand there are those optimists (mostly economists and political scientists) who believe that unconventional sources of oil, technological advancement, market forces and increased investment will enable us to produce more oil or invest substitutes and hence meet increasing demand. They expect a smooth shift to new and better energy resources driven by market forces. Most prominent advocates of this group are the US Energy Information Agency, the International Energy Agency and CERA. They all argue that no peak is visible before 2030 and "above-ground issues" are more important than below ground issues. Several other oil companies, such as ExxonMobil and Eni, are supporters of the optimists.

In the middle stands another camp, called the mitigationists, warning of the risks and potential consequences of approaching peak oil. They suggest looking beyond conflicting forecasts and focusing on the consequences of underestimating the severe consequences of the peak oil problem as well as urging mitigation efforts to begin immediately.

It is impossible to determine who is correct because forecasts for peak oil vary due to different methodologies, data, definitions and assumptions used. While some optimists tend to lack knowledge on the Hubbert method, mix reserves with resources and productive capacity with flows, many pessimists underestimate the power of technology. It is a historical fact that early global peak oil warnings of the pessimists didn't come true. It is another historical fact that none of the optimists could see oil production peak in the North Sea and gas production peak in North America coming, oil prices could reach triple digits and the global economy could register record growth rates despite high oil prices. So, the blame game has no end.

Another frontline dividing peak oil camps is whether a decline in global oil production will be preceded by a peak or a plateau; some pessimists foresee what they refer to as a "bumpy plateau" a consequence of price and demand signals in the peak-oil transition years, contrary to many other pessimists who expect a sharp decline after the peak. The majority of the optimists believe the decline in production (which is decades away) will be preceded by an "undulating" plateau (as coined by CERA) rather than a peak. Optimists believe that the decline in conventional oil will be very slow which will be more than offset by unconventionals. Pessimists on the other hand argue that unconventionals will only postpone the peak for some time but the peak is inevitable.

The essential input to peak oil estimates is the ultimately recoverable oil reserves (URR), the total quantity of oil that will ever be produced. URR is the sum of cumulative production, "remaining" reserves and undiscovered potential. While pessimists generally rely on a URR of less than 3 trillion barrels, optimists prefer to use a value of more than 3 trillion for conventional oil as argued for by the US Geological Survey (USGS) 2000 assessment, based on data through 1995. That assessment indicated that the bulk of conventional oil yet to be produced in the world resides in fields that have already been discovered.

Virtually everybody, regardless of which side of the peak oil argument they stand, agrees that approximately 1 trillion barrels of oil have so far been extracted and consumed over the approximately 150 years since the first commercial oil production in Romania. What is not agreed upon is the size of the reserves and yet to be discovered potential. For example, the increase in reported OPEC reserves in the mid 1980s (approximately 300 billion barrels) is still questioned by many to be purely political, since only an insignificant part could be explained by new discoveries.

Concluding remarks

Whether we like it or not, oil is a finite natural resource. Its global production peak (either followed by a plateau or decline) will eventually come. The challenges facing the oil industry and the developments witnessed in the oil market since the beginning of this century indicate that peak oil is in sight. We are fast approaching the end of the easy oil era.

It is almost impossible to know exactly when the peak will occur, mainly because of the pathetically poor quality of data, classifications and definitions on production, reserves and resources. The world urgently needs a comprehensive world oil reserve and resource assessment in which all stakeholders will participate. Still relying on USGS estimates based on 13-year-old data does not make sense any more. More importantly, instead of wasting time on who did what and why, we should concentrate our efforts on contributing to better understanding future realities.

this article of mine was originally published in todayszaman on January 7, 2007 (a Turkish daily newspaper in english)


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