Friday, January 29, 2010

Global Crude Supply: Is the Oil Peak Near?

by Matthew R. Simmons

Chairman and CEO
Simmons & Company International

In February, one of the more remarkable events in a remarkable industry took place as senior figures in Saudi Arabia's energy administration appeared before a group of industry experts gathered in Washington, D.C., to defend their country's petroleum policies and assure the world that there is no impending crude oil shortage...

The Saudis were moved to appear before the Center for Strategic and International Studies after I posed a very serious question: is Saudi oil production near its peak? That question was framed in an extensive study I conducted and supplied to the Saudis prior to presenting it on February 24 before the Center. It also anchors a book that I will soon publish.

In response, the Saudis sent Mahmoud Abdul-Baqi, vice president of exploration for the Saudi national oil company, Aramco, and Dr. Nansen Saleri, manager of Aramco's reservoir management, to present the Arabian case. The fact that Aramco would send such talented and experienced oilmen to address my question demonstrates, in my opinion, that the Saudis' commitment to their stated goal of being the world's most dependable and conscientious supplier of crude oil is genuine.

On that note, I will recapitulate my concerns, log in the Aramco position and then let you come to your own conclusion....

Saudi Arabia's Giant Fields

As readers of this publication are entirely aware, stable and reasonably priced energy supplies have brought civilization to its current status, and a continuation of these supplies is absolutely essential to keep us from receding to the Stone Age.

Of all the known reservoirs of crude oil in the world, none has been more prolific than those beneath a portion of Saudi Arabia's eastern province, a small part of a kingdom of just 26,500 square miles, roughly two-thirds the size of the state of Virginia. Underneath this territory lie five giant oilfields that have produced some 90 percent of all Saudi Arabian production for the last half century. Up to 60 percent of all Saudi oil has come from Ghawar, the world's largest oil field, discovered in 1948.

These simple facts bring us to the crux of my question: When will these few fields finally peak? It has to happen sometime. And even more worrisome is the follow-up question: What is our backup plan when the end is finally in sight?

The Saudis' response, in a nutshell, is that the end isn't in sight; not even close. But I'm an energy worrier. In my lifetime, I've already seen U.S. oil and gas production peak and go into decline. I've seen the signs that the North Sea has peaked, although there will be some who say I'm premature. Just in the last couple of years, I've seen the rest of non-OPEC crude supply flatten when it was supposed to have surged. And juxtaposed with these ominous signs is a world appetite for oil and natural gas that grows inexorably.

The End of the Commodity Price Cycle?

What all of us in the energy business have had drummed into our heads is the cyclical nature of the world's most precious and critical commodity - energy. Time and time again we've seen demand overtake supply, prices go up to the point that production increases while demand is either curtailed or destroyed, and finally a point where supply once again overtakes demand, and prices crater.

No one in the industry likes that grim reality, and no one has done more to take the peaks and valleys out of oil prices than Saudi Arabia, the leading member of OPEC. Granted, OPEC took its initial lessons from the Texas Railroad Commission, which began controlling production of crude in the early days of the East Texas oil field. It has certainly gone much further, though, and on a far grander scale. After all, Texas is no longer a major crude producer, and Saudi still is.

But as I asked last year in this publication ("The Dawning of a New Oil and Gas Era: Is a Sea Change Ahead?" World Energy Vol. 6, No. 3), is something fundamentally different under way that will usher in a dramatically new era? That question was posed after I concluded a study that indicated higher natural gas prices had not triggered the increase in production and gas reserves that we would have expected due to increased exploration and development activities.

My study also showed that although high prices no longer trigger any significant supply increases, any price collapse still causes a rapid downturn in drilling and delay or cancellation of expensive new energy projects. Add to this unsettling situation the fact that just 1-3 percent too much energy creates a glut capable of knocking down prices, and even 1 percent too little can bring an economy to its knees with a crisis that slows the wheels of progress to a crawl or even a halt.

The Saudi "Plug" Factor

In this picture of global energy uncertainty, the Saudi crude oil juggernaut has been - and still is to many people - the friendly giant that can put things to rights with a snap of his fingers, plugging in an increased flow of crude to prevent or ameliorate an oil shock. That, of course, is the contention of Aramco, and why it sent two of its top experts to the U.S. to deliver the most detailed presentation of its operations ever made.

Currently, according to Mr. Abdul-Baqi and Dr. Saleri, Aramco has a production capacity of 10 million barrels a day (b/d), which can easily be increased by up to 5 million b/d if the world requires it. While I have no reason to doubt the integrity of the gentlemen from Aramco, I have certainly been in the position of questioning production figures in the past. And I'm not alone in questioning the Saudi crude oil situation.

In a copyrighted story published the same day that the Aramco executives and I appeared before the group assembled at the Center for Strategic and International Studies, the New York Times noted that Saudi Arabian production today is only 8 million b/d, 20 percent below the Saudi estimate of current production capacity. Add to the uncertainty the fact that both the International Energy Agency (IEA) and America's Energy Information Agency (EIA) have been subject to questions about their data systems, and their predictive track records have been awful. Until February 24, the best estimates of Saudi and other OPEC crude output came from tanker traffic consultants. While Saudi production reports are welcomed, I for one would like a second-party confirmation. I'll address the issue of transparency in the Arabian petroleum scene later in this article.

Yet even if we accept Aramco's production capacity of 10 million b/d as entirely accurate, the issue of future production cannot be a foregone conclusion. Two questions will occur to those, such as I, who worry. First, can the Saudis really open the tap and produce up to 5 million b/d more? Jeff Gerth, the New York Times writer, quoted several credible sources to the contrary. One of those was Edward O. Price, Jr., a former executive with Aramco and Chevron, who said Saudi could pump 12 million b/d for "a few years, but the world should not expect more from the Saudis." Faith Birol, chief economist for the IEA, told Gerth that no Saudi increase in production would be possible without large-scale foreign investment, which would be politically difficult for the Saudi monarchy, particularly in view of current East-West tensions. Aramco's Dr. Saleri disputes this contention, having stated to Petroleum Intelligence Weekly last December that Aramco's own finances would be sufficient to boost production to 10 million b/d.

Second, if world conditions demand an additional 5 million b/d and Aramco delivers, how long can this higher output last, and will it end up damaging the key reservoirs already struggling with high water cuts? Mr. Price's pessimistic opinion notwithstanding, the Saudis maintain they can do it for 50 years. I must admit that even to a worrier, the Saudis' answers had a degree of comfort, especially to the extent that they were based on past history.

Saudi Arabia's Principles of Reliability

In Saudi Aramco's February presentation, in the pages of this magazine over the past six years and in many other venues across the world, representatives of the Saudi energy industry have consistently stressed their desire and commitment to be good stewards of the world's most precious treasure. The principles they point to are:

• Sustainable performance

• Maximum hydrocarbon recovery

• Life-cycle economics

• Prudent reserves management

• Excellence in safety and environmental practices

I would say that all these are worthy of following, although investor-owned companies may not have the luxury of spending as much time and resources on maximizing recovery and sustaining performance of specific assets as a company that does not have to answer to stockholders or regulatory authority.

In the field practices section of their presentation on February 24, the Aramco executives based their hopes for maximizing recovery on leading-edge technologies, advanced diagnostics and careful reservoir monitoring. And they supported their abilities with a report of depletion rates from 1 percent for their best efforts to 4.1 percent at the worst, compared to 4.2 percent at Prudhoe Bay, 4.5 percent in East Texas and 9.6 percent for Brent.

Indeed, sustainability of existing reserves always comes down to managing the depletion rate. Moreover, when massive water injection keeps reservoir pressures high, this puts off normal decline rates until this miracle ends. These declines can be gigantic. Yet finding increasing depletion rates in oil and gas reserves the world over has continued to alarm me, and a trip to Saudi Arabia last year to better understand the situation raised more questions than it answered. Chief among them were the location of the "shut-in capacity" that could come to the world's rescue, why Saudi Arabia has such a high concentration of old fields, and why Aramco is making such extensive use of technology, particularly water injection.

Enhanced Recovery, Peaking and Rapid Decline

My search for answers led me to a 1961 article in the Journal of Petroleum Technology on evaluating water-oil displacement efficiency. Subsequently, I turned to the archives of the Society of Petroleum Engineers, reviewing some 200 papers relating to Saudi Arabian oil challenges from 1961 to 2003. As I progressed to reading and analyzing more recent papers, the problems associated with water injection grew both in volume and in intensity.

The water issue directly relates to the sustainability of the five giant Saudi fields because all five use water drive to create their fabulous wellhead oil flows. For example, the Saudis have been using water injection in Ghawar since 1965. I have questioned whether the extensive use of water injection may threaten the viability of the Saudi fields, and Aramco has responded that it does not. Certainly, the fact that Ghawar continues to pump 5 million b/d supports the Saudi position. However, I believe this issue needs more independent scientific investigation. Indeed, my research has shown that water injection and other enhanced recovery techniques may very well increase depletion rates, accelerate production peaks and hasten a steady decline thereafter.

A good example is the Yibal field in Oman, which was Oman's sole giant oilfield. This field was heavily water-injected, and as vertical wells were becoming obsolete in the early 1990s, horizontal drilling began. By 1997, Yibal production hit a new record at 250,000 b/d and the field capacity was expanded. However, four years later, production had fallen to under 90,000 b/d, and today it's barely half of that. Most observers were caught by surprise, but my studies show that Yibal's peak and rapid decline were typical of many other major fields. The East Texas oil field is a classic case, but there are many more (Fig. 1).

The Samotlor Field in Russia hit its peak production of 3 million b/d in 1979 and maintained that flow until 1983. Its decline started in 1984 with a 200,000 b/d drop, where it stayed until mid-1986. But four years later, it had lost a million b/d, and by 1994, it was producing barely 500,000 b/d. Prudhoe Bay, Alaska took three years to reach 1.5 million b/d in 1979, a level it maintained for 10 years. But then the decline rate began to increase. By 1999, production was no more than 600,000 b/d. Brent lost its peak even more rapidly, holding at 425,000 b/d for only a year in 1984, then plummeting to less than 100,000 b/d by 1990.

The Production/Exploration Equation

To this point, I have focused on Saudi reserves that have been identified. In round numbers, Aramco believes it can safely say that its country was endowed with nearly 700 billion barrels of oil (termed OIIP, or oil initially in place), of which 99 billion barrels have already been produced, 260 billion are proved, another 103 billion are probable or possible and a final 238 billion are contingent (Fig. 2). Further, Aramco believes that current and future exploration will expand the estimate of total Saudi OIIP barrels to 900 billion by 2025. Current Saudi reserves, by most accounts, equal about one-fourth of total world crude reserves.

Obviously, if Saudi Arabia just stays at its current production rate of 8 million b/d, or about 3 billion barrels/year, it would only have produced one-third of the 900 billion barrels, if they actually exist, 100 years from now. Isn't that enough to calm the fears of the most nervous of energy worriers? Yet Ghawar, which is producing 5 million b/d, is not a 50-year prospect to many observers. I found a 1975 report from Aramco that estimated Ghawar's total recoverable reserves at 60 billion barrels. At that time, over 400 wells had tapped the field, oil/water contact had been carefully mapped and geoscientists from Exxon, Mobil, Chevron and Texaco all agreed on the estimate.

Aramco reported Ghawar has been producing at just under the 5 million b/d level since 1993 and has now produced 55 billion barrels of cumulative oil. If the 1975 ultimate proven recoverable reserve estimate was correct, Ghawar is about done. However, Aramco says Ghawar is only 48 percent depleted, meaning the pie got much bigger. Maybe it did, and if Saudi production stays as steady and dependable as it has, I suppose I'll go down in energy history as the industry's biggest alarmist. But history has already shown that maintaining crude oil flows is by no means easy, and often impossible, regardless of the size of the estimated reserves.

Included in the Aramco presentation was the fact that it has average production costs somewhere around 50 cents a barrel, while the rest of the industry is looking at $3-5 a barrel (Fig. 3). That's very good news, but is it reasonable to anticipate the Aramco lifting costs can stay that low when the rest of the world's producers are seeing costs go up every day? Are some of these very low prices simply driven by heavily subsidized water and elecricity fees? Let's face it, technology costs money.

Beyond the costs for maintaining the status quo is the issue of finding new oil beneath the desert sands. In fact, there has already been a great deal of exploration for new giant fields in Saudi Arabia, and considerable development work remains in 85 oil and gas fields that have been found but not tested. Yet the rest of Saudi Arabia has been intensely explored, with few significant fields having been found. The "newest" oil in the Middle East is the 1989 discovery of the Hawtah Trend in Central Arabia, which came after 120 drilling or seismic penetrations. The Hawtah and several adjacent fields combine to produce 200,000 b/d of condensate, but bacteria and corrosive aquifer water have damaged the wells and reservoirs, and the newest Middle East oil is getting old.

Worse, the next generation of Saudi oil will undoubtedly be harder to extract, coming from bypassed oil pockets and reservoirs above and below the prime producers that will require more complex and more expensive production techniques. Three oilfields with complex production histories are next in line: Qatif, Abu Sa'fah and Khurais. The EIA reported Aramco will spend $3 billion on just one project at Khurais that should produce new capacity of 800,000 b/d. Enhancements at Qatif and Abu Sa'fah are expected to add another 800,000 b/d, by Aramco estimates.

Global Energy Transparency

The information that flowed from Aramco earlier this year was a welcome improvement, and absolutely necessary for global energy management. It appears that we can expect the trend to continue and, hopefully, accelerate. Aramco is opening the door to more joint exploration with foreigners, meaning more international money, and more scrutiny, will be arriving in Saudi Arabia. The world's continued economic development is at stake.

Current global crude oil consumption of 81 million b/d is expected to climb to 120 million b/d by 2030. Most observers see Saudi Arabia contributing most of that extra 40 million b/d. We do have a quarter of a century to get there, but it won't be easy, and it won't be cheap. To do the best job, the global energy industry needs true energy transparency.

At a minimum, from the International Energy Agency, we need far better demand and cost data and much more accurate information on the decline rate of non-OPEC production. From OPEC, we need timely field-by-field production and well-by-well data, budget details and third-party engineering reports. And all of us need to be committed to financial reforms that will bring the wild price volatility of oil and gas under control, with a realistic economic model for how oil and gas need to be priced. OPEC's range of $23-$28/barrel already seems to be defunct, and besides, the OPEC producers shouldn't be left to grapple with price continuity on their own. We must all be involved.

There are glimmerings that alternative energy sources may become large enough to be realistic substitutions for oil and gas, but most people don't see that happening for another two decades. Hydrogen is another possibility, although right now, the most realistic sources of hydrogen seem to be from hydrocarbons.

In the various Aramco responses made in Washington during late February, Dr. Saleri was quoted as saying, "Mr. Simmons is a banker pretending to be a scientist." He then said he could read 200 studies on neurology, but I still wouldn't want him wielding the knife if I needed brain surgery. I agree. But if he were contemplating surgery himself, I bet he would like to know the success ratio for the type of procedure recommended, not to mention the track record of the surgeon he picked to operate. I want the Aramco projections to be correct and Saudia Arabia to continue as the friendly giant that keeps the wheels of progress energized. But I can never accept the simple "trust me" solution, and I believe it will be dangerous for the world to continue to fly blind on the issue of adequate energy supplies. The time to begin a new era of energy transparency is now.

Matthew R. Simmons is chairman and CEO of Simmons & Company International, a specialized energy investment banking firm. The firm has guided its broad client base to complete nearly 500 investment banking projects at a combined dollar value of approximately $58 billion.
Mr. Simmons was raised in Kaysville, Utah. He graduated cum laude from the University of Utah and received an M.B.A. with distinction from Harvard Business School. He served on the faculty of Harvard Business School as a research associate for two years and was a doctoral candidate.
Mr. Simmons founded Simmons & Company International in 1974. Over the past 28 years, the firm has played a leading role in assisting its energy client companies in executing a wide range of financial transactions from mergers and acquisitions to private and public funding. Today the firm has approximately 130 employees and enjoys a leading role as one of the largest energy investment banking groups in the world. Its offices are in Houston, Texas and Aberdeen, Scotland.

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