Peak Oil

Why the oil industry doesn't want you to remember the last 14 years

Resource Insights,

2 September, 2012

This is the first of a six-part series introducing readers of The Christian Science Monitor to concepts useful in understanding the Resource Insights blog. Selected posts from Resource Insights will begin to appear on the Monitor's Energy Voices blog starting this month.

What were the prices of oil and gasoline in 1998? Do you remember? Without looking them up (or looking below this line), make your best guess.

I've been taking an informal poll to find out what people remember about oil and gasoline prices in that year. So far, only one person has correctly characterized prices back then. Most guesses have clustered around $2.50 to $3 a gallon for gasoline (in the United States). Only one person could come up with a crude oil price which she guessed was around $55 a barrel. The answers show a vague recollection that oil and gasoline were cheaper than they are today. But just how much cheaper has been lost down the memory hole.

Okay, I know the suspense is killing you. Here's how gasoline and oil fared in 1998. The nationwide average price of a gallon of gasoline in the United States in December of that year was 95 cents. The closing price for a barrel of crude oil sold on the New York Mercantile Exchange on December 31 was $12.05. Just three weeks earlier the price of oil had hit its nadir for the year at $10.72. Oil had started the year above $17 and steadily slid as the Asian financial crisis slowed the world economy and reduced oil demand. Gasoline prices dropped only a little during the year starting from the January average of $1.09 a gallon.

Why does the oil industry want you to forget this? Because after a 10-fold increase in the price of crude oil and a fourfold increase in the price of gasoline, the industry is once again trying to sell the same story of continued abundance that they were selling back in the late 1990s. But the manyfold increase in oil prices ought to make everyone doubt an industry which has repeatedly told us that huge supplies are just around the corner, and prices are headed for a crash.

Perhaps the best example of the oil industry's "Wrong Way Corrigans" is industry mouthpiece Daniel Yergin, head of Cambridge Energy Research Associates (CERA), a prominent energy consulting firm. For a long time Yergin has been a frequent guest on prominent television news programs and a source for many print journalists. He is a darling of the media on energy issues, a media which is too polite to confront him with his abysmal record of predictions in the oil market. He was wrong in his public pronouncements every step of the way from the 1998 low in oil prices right up to the all-time highs of 2008, frequently predicting a large buildup of new supply and crashing prices. (One wonders why clients of CERA continue to buy the company's research when it has been so wrong for so long. But that's a story for another time.) Only at the end of 2008 did oil prices finally crash and then only because the world economy was headed into the worst economic decline since the Great Depression. But as soon as the economy revived even tepidly, prices rose back to $80 a barrel and then above $100 which is about where they are today.

The reason for high prices is actually quite obvious. Crude oil production worldwide has been stuck between 71 and 76 million barrels per day since 2005 (calculated on a monthly basis). Oil volumes have been tracing out a troubling bumpy plateau that many fear will mark the all-time peak in world production. These numbers are reported by the U.S. Energy Information Administration, the statistical arm of the U.S. Department of Energy, and are widely considered to be the most reliable available. They reflect total production of "crude oil including lease condensate" (which is the definition of crude oil) from all sources worldwide.

Oil production has stalled despite the huge incentive that record high prices are providing for oil exploration and development. And, despite enormous spending by oil companies on exploration and drilling worldwide, we have only just kept production on a plateau for the last seven years. These high prices and enormous capital spending were the reasons given by Daniel Yergin for the expected buildup of production volumes. So what went wrong?

The simple answer is that we've exhausted the easy-to-get oil and are now left with mostly the hard-to-get oil. It only makes sense that the early oil pioneers harvested the easy oil first. Why go after the hard stuff at that point? We've since learned how to extract oil that is much harder to develop. This includes deposits far offshore and deep below the seabed as well as those locked in the Canadian Tar Sands, deposits that must undergo expensive and energy-intensive processing to convert what is really bitumen, a goopy, thick hydrocarbon, into what we call oil.

And, this leads me to a crucial concept which I find myself repeating over and over again in response to all the foolish Daniel Yergins of the world: The critical factor in the oil markets and a global economy dependent on large, continuous supplies of oil is the rate of production. The rate is the key, not the size of the world's reserves. It is the size of the tap, not the size of the tank that matters.

Let me offer another analogy to help explain. If you inherit a million dollars with the stipulation that you can only withdraw $500 a month, you may be a millionaire, but you will never live like one. That is increasingly the situation we face with oil. There may be huge resources of tight oil (often mistakenly referred to as shale oil) and of oil-like substances such as tar sands. But the expense, the necessary energy and increasingly, the amount of water required to extract and process them is so great that we have been unable to lift the worldwide rate of production significantly above its current plateau for a sustained period during the last seven years. Even with all our vaunted new technology, we have only just barely been able to replace the capacity lost each year to the inexorable decline in the rate of production from existing oil fields.

Recently, the head of a company well placed to judge trends in the worldwide rate of oil production said he believes that the all-time peak is in. Core Laboratories CEO Dave Demshur told attendees at the Denver Oil & Gas Conference last month that "[t]he maximum yearly oil production of the planet is taking place now." Core provides well analysis and reservoir management to oil and gas companies in practically every major oil region of the world. Demshur's statement is an unusual admission from an industry insider with access to information that spans the entire industry.

The truth is we won't know for sure that we've passed the peak in world oil production until long after it occurs. It may be a decade after the event before oil production turns down definitively and the peak becomes obvious for all to see.

Just to clarify, here's what peak oil does NOT mean:

• Peak oil does not mean we are running out of oil. This is a canard used by the oil industry to confuse the public. Nobody who understands world peak oil production ever says that it means we are running out. In fact, we won't run out of oil for a very, very long time. At the peak the rate of production will cease to rise, probably trace a plateau for a time, and finally begin a possibly slow and bumpy decline. That means we'll have less and less oil available each year. As oil becomes more and more expensive, we will use less, and we will ultimately reserve it for critical purposes for which we cannot find good oil substitutes.
• Peak oil does not mean that we won't find any more oil. We are finding oil every day. We're just not finding enough and putting it into production fast enough to grow production in the face of declining flows from existing fields.
• Peak oil does not mean the immediate collapse of modern civilization. However, if we stand still and do little to address oil depletion, peak oil will likely result in immense difficulties.

The industry and its paid spokespersons try to dazzle the public with talking points that include the notion that we have more oil reserves than we've ever had. That is questionable, and I'll explore that claim in a later piece. But again, I emphasize that reserves are not the salient point. It is and always will be the rate of production that matters more. If oil production stopped for a sufficiently long period--enough to drain all aboveground supplies--modern civilization as we know it would collapse. The amount of reserves would not matter since the rate of production would have dropped to zero.

What matters is how much we can produce for continuous input into the world economy. As you might intuit, we've built a financial system and physical infrastructure premised on continuous and rising levels of oil consumption. That's why peak oil matters so much, and why flat oil production has been a large contributing factor to the unstable world economy in recent years.

To further illustrate the importance of rate, consider the following: Half of all oil consumed since the beginning of the oil age has been consumed since 1985. We consumed exponentially larger amounts nearly every year until 2005 when a number of factors conspired to constrain supplies. We frequently hear about multi-billion barrel discoveries and think (wrongly) that oil must surely be plentiful as a result. So, here's another question to ponder: How long does one billion barrels of oil last the world at current rates of consumption? If you guessed something close to 12 days, you have a sense of the enormous challenges humans face in extracting finite resources at ever higher rates. Just multiply those multi-billion barrel discoveries by 12 to find out how many days the oil age might be extended by each discovery. You'll find the answer is, "not many."

Perhaps it will seem puzzling that experts inside the industry--with a few notable exceptions--cannot grasp that the rate of production is the central issue. The best explanation I can offer is to quote author Upton Sinclair: "It is difficult to get a man to understand something, when his salary depends upon his not understanding it!"

And, here is where we get to the motivations behind the sunny optimism of the oil industry. If the public understood that oil supplies might be nearing an irreversible decline, it would demand the deployment of alternative fuels and efficiency measures to soften the blow in order to give us time for a transition to a society based on something other than oil. That would ultimately reduce demand for oil products and eventually end our dependence on oil. Oil companies might get stuck with significant inventories in the ground that they cannot sell, at least not at the prices or in the quantities they would like.

The more immediate problem for oil company executives is that their companies may soon find it impossible to replace all their oil reserves. Oil companies strive to replace at least 100 percent of what they produce so that their reserves don't fall. If investors come to believe that a failure to replace reserves will be ongoing year after year, they will mark down oil company share prices significantly. In fact, it's already happened, and it's likely to happen with more frequency as more companies struggle to reach 100 percent replacement. Such share price declines would, of course, make a lot of oil executives significantly poorer as the value of their stock and stock options plummet. Essentially, oil companies would be recognized as self-liquidating businesses.

All of this the oil industry wants you to ignore as it undertakes yet another public relations campaign to convince the world that supplies will only grow from here. Naturally, with prices near $100 a barrel, the public needs reassurance. The campaign is designed to lull both the public and policymakers into a somnolent surrender to a business-as-usual future that will leave us unprepared for the momentous challenges ahead.

Oil is the central commodity of the modern age. As of 2011 it provided one-third of the world's energy and the basis for countless petrochemicals necessary to the functioning of modern society. Oil's role in transportation remains critical; 80 percent of the world's road, rail, air and sea transportation fuel is derived from petroleum, and in the United States the number is 93 percent. Good substitutes for oil in transportation are still hard to come by.

No one can know exactly when world oil production will peak--not me, not the world's oil companies, not any government agency. The dangers we face if we are unprepared are potentially quite severe. With worldwide oil production essentially flat for the last seven years, the sensible thing to do would be to get ready now as quickly as we can.

Given what's at stake for oil company managements, it should be obvious why they are telling us not to worry. Given the publicly available production data, the persistently high price of oil, and the failure of oil companies to expand worldwide production even after enormous expenditures and effort, it should also be obvious why we shouldn't fall for the industry's beguiling but wildly misleading tale.

Has OPEC misled us about the size of its oil reserves? Does it matter?

 

Resource Insights,

8 September, 2012

This is the second of a six-part series introducing readers of The Christian Science Monitor to concepts useful in understanding the Resource Insights blog. Selected posts from Resource Insights will begin to appear on the Monitor's Energy Voices blog this week. Click here to read the first part of this series.

Has OPEC misled us about the size of its oil reserves? The short answer is probably. The long answer is that currently, there is no way to know for sure.

The next question we should ask is: Does it matter? The answer is most definitely yes. OPEC, short for the Organization of Petroleum Exporting Countries, currently claims that its 12 members hold 81.3 percent of the world's oil reserves. And, with few exceptions the world believes them. Trouble is these reserves "are not verified by independent auditors," according to a study (PDF) done by the U.S. Government Accountability Office, the nonpartisan investigative arm of the U.S. Congress. OPEC reserves are simply self-reported by each country. Essentially, OPEC's members are asking us to take their word for it. But should we?

It ought to give us pause that the reserve numbers OPEC countries release are used in major reports produced by the U.S. Energy Information Administration (EIA); the Paris-based International Energy Agency (IEA), a consortium of 28 of the world's oil importing nations; oil giant BP which annually publishes the widely cited BP Statistical Review of World Energy; and myriad other organizations. Reports from the two agencies cited above and BP are frequently consulted by governments, industry, banks and investors around the world for policy formulation, long-term planning, and lending and investment decisions. Yet these groups seem blissfully unaware of the caveats surrounding the numbers in those reports and by extension surrounding more than 80 percent of the world's oil reserves.

Keep in mind as we go along that the sometimes astronomical numbers thrown around for world oil reserves by the uninformed or by those who intend to mislead us either have no basis in fact or actually refer to "resources." Resources are only an estimate of oil thought to be in the ground based on rather sketchy evidence. And, most of that oil will never be recoverable. Reserves, however, are what can be produced at today's prices from known fields using existing technology. It turns out that reserves are only a tiny fraction of so-called resources.

Now here's the caveat from the International Energy Agency in its World Energy Outlook 2010:

Definitions of reserves and resources, and the methodologies for estimating them, vary considerably around the world, leading to confusion and inconsistencies. In addition, there is often a lack of transparency in the way reserves are reported: many national oil companies in both OPEC and non-OPEC countries do not use external auditors of reserves and do not publish detailed results.

"National oil companies" refers to government-owned companies which typically control all oil development within a country.

The BP Statistical Review of World Energy for 2012 provides this explanatory note under a table listing oil reserves by country:

The estimates in this table have been compiled using a combination of primary official sources, third-party data from the OPEC Secretariat, World Oil, Oil & Gas Journal and an independent estimate of Russian and Chinese reserves based on information in the public domain. Canadian oil sands 'under active development' are an official estimate. Venezuelan Orinoco Belt reserves are based on the OPEC Secretariat and government announcements.

The key words are "OPEC Secretariat" which refers to the OPEC staff located in an office in Vienna. That office is where BP presumably gets its information about OPEC reserves. The EIA lists the OPEC Annual Statistical Bulletin put out by--you guessed it--the OPEC Secretariat. Alas, the Annual Statistical Bulletin tells us under the heading "Questions on data" that "[a]lthough comments are welcome, OPEC regrets that it is unable to answer all enquiries concerning the data in the ASB." In other words, trust us. So, information about OPEC reserves comes either from the OPEC offices in Vienna or from member countries. Some analysts may adjust those figures based on the few shreds of evidence that are available outside of official government pronouncements. But, in reality, there are almost no hard facts when it comes to OPEC reserves.

Strangely, many of these countries say that a detailed audit of their fields by independent observers is out of the question because oil reserves are a state secret. And, yet those countries report their reserves to OPEC which publishes them for all to see. So, are oil reserves in many OPEC countries a state secret or not? Apparently, what's secret is the field-by-field data that would tell us whether the reserves claimed by these countries are actually there. Are there reasons to believe that if we saw this data it would contradict the official overall number provided by some countries? In a word, yes.

First, OPEC allocates production levels among its members. It does this to control the flow of oil to world markets and thus to manipulate the price. OPEC bases production quotas for its members in part on the size of each member's reserves. When this policy was first established in the 1980s, reported reserves for several OPEC members jumped between roughly 40 and 200 percent within one year--not always the same year--as each country jockeyed for a higher production quota. Based on EIA data, here's what it looked like:

Country	Reserves in Barrels (Year)	Reserves in Barrels (Year)	Percentage Increase
Iran	48.8 billion (1987)	92.9 billion (1988)	90.4%
Iraq	47.1 billion (1987)	100 billion (1988)	112.3%
Kuwait	66.7 billion (1984)	92.7 billion (1985)	39.0%
Saudi Arabia	172.6 billion (1989)	257.6 billion (1990)	49.3%
United Arab Emirates	33.1 billion (1987)	98.1 billion (1988)	196.4%
Venezuela	25.0 billion (1987)	56.3 billion (1988)	125.2%

Not every country participated in the free-for-all. But the countries with the largest exports participated with a vengeance. There was no drilling program in any of these countries that could have explained such jumps in reserves.

The competition continues to this day. In October 2010 Iraq announced an increase in its oil reserves from 115 billion barrels to 143.1 billion barrels. No attempt was made to hide the reason for the increase: "Falah al-Amri, the head of the country’s State Oil Marketing Company, suggested that future quota calculations might have been a factor in the revision." A week later Iran raised its reserves number from 136.6 billion barrels to 150.3 billion barrels, presumably in order to maintain its position within the OPEC production quota system. These numbers have been dutifully included in the latest statistical compilations of both EIA and BP, as if the two hadn't gotten the memo that Iraq's and Iran's increases were reported merely for quota reasons and not because of any particular discoveries.

Perhaps even more astounding is that some OPEC members don't even take the oil reserves reporting game seriously any more. Logic dictates that there should be at least small adjustments up or down in reserves each year as new fields are developed and old ones decline. The world of geology simply cannot yield precisely the new reserves needed to replace exactly the amount of oil extracted from existing fields each year.

And yet, the United Arab Emirates has been reporting 97.8 billion barrels of oil reserves every year since 1997. Kuwait has been reporting 104 billion barrels each year since 2008. Iraq shows long periods from 1980 onward when reserves don't change, the latest running from 2004 to 2011 during which reserves supposedly held absolutely steady at 115 billion barrels. Algeria has reported 12.2 billion barrels from 2008 onward. At least Saudi Arabia has demonstrated a certain sensitivity to appearances and has adjusted its reserves number slightly from year to year. And yet, that number has remained within a narrow range of 260 to 267 billion barrels from 1991 to the present. All of these numbers suggest that depletion from existing fields is taking absolutely no toll on OPEC's reserves. Even if that's true, we have no way of verifying it.

The second reason to doubt OPEC's official oil reserve numbers is that two insiders have told us not to trust those numbers. The now deceased A. M. Samsam Bakhtiari, an executive for the National Iranian Oil Company, told the Oil & Gas Journal all the way back in 2003 the following: "I know from experience how 'reserves' are estimated in major Middle Eastern (and OPEC) countries...And the methods used are usually far from scientific, as the basic knowledge for such a complex exercise is not at hand." He estimated that Iranian reserves were about 37 billion barrels, not the 90 billion that were being cited at the time.

Back in 2007 Sadad al-Husseini, former executive vice president for exploration and production at Saudi Aramco, the state oil company that controls all oil development in Saudi Arabia, told a conference in London that world oil reserves had been inflated by 300 billion barrels. That number almost matches the increases in OPEC members' reserves for quota reasons in the 1980s, and it represented about a quarter of all reported reserves in 2007. As a result, to this day al-Husseini remains skeptical of claims that world oil production will rise much from here.

Another piece of evidence that casts doubt on OPEC members' reserve claims came to light in 2005. That year Petroleum Intelligence Weekly, an industry newsletter with worldwide reach, obtained internal documents from the state-owned Kuwait Oil Co. The documents revealed that Kuwaiti reserves were only half the official number, 48 billion barrels versus 99 billion. Since then policymakers and the public seemed to have ignored the entire incident. The BP Statistical Review lists Kuwait's reserves as 101.5 billion barrels as of 2011. The EIA shows them as 104 billion. Skepticism apparently is taking an extended holiday at BP and EIA.

Measuring oil reserves remains something of an art. Even large publicly traded oil companies with armies of petroleum geologists and engineers who operate under strict U.S. Securities and Exchange Commission rules for estimating reserves--even these companies don't always get it right. In 2004 Royal Dutch Shell had to lower its reserves number by 20 percent, a huge and costly blunder for such a sophisticated company. If Shell can bungle its reserves estimate, then how much more likely are OPEC countries which are subject to virtually no public scrutiny to bungle or perhaps manipulate theirs.

I said in a previous piece that the rate of production is the key metric when evaluating the success of the world's oil production and delivery system. But sustained production of oil depends on the size and quality of reserves. If the world does indeed have 300 billion fewer barrels of reserves than it thinks it does, that has implications for how long the current rate of production can be maintained. (It has been stuck between 71 and 76 million barrels per day since 2005.) And, that is why the mystery surrounding OPEC's reserves, which supposedly constitute 80 percent of the world's reserves, is so disturbing. Even more disturbing is how much this mystery is ignored or perhaps not understood by policymakers, industry and the public.

We shouldn't be the least bit exultant over claims that we have more oil reserves than we've ever had before. First, we are using up that oil at a faster rate than ever before. Second, much of what is currently parading as reserves may not be. Third, the plateau in worldwide oil production since 2005 is actually consistent with a smaller reserve base.

Given all this I think we can safely say that when it comes to the official statistics on oil reserves, there is likely to be less than meets the eye. And that begs the question: Does it really make sense for the world to chart its energy future based on such dubious information?