http://www.cera.com/aspx/cda/client/report/report.aspx?KID=5&CID=10720
Understanding the Building Blocks
by Peter Jackson, Senior Director, IHS Cambridge Energy Research Associates
Context: Predicting Supply in a Complex World
Fears about "running out" of oil are recurrent. At their strongest, they coincide with periods of high prices and tight supply-demand balance. The latest such period of "peak oil" concerns became very evident from 2004, when strong oil demand ran up against capacity constraints. In contrast, IHS CERA’s reference case for global liquid productive capacity shows growth through 2030 to around 115 million barrels per day (mbd) and finds no evidence of a peak in supply appearing before that time.
Hydrocarbon liquids—crude oil, condensate, extra heavy oil, and natural gas liquids—are a finite resource; but based on recent trends in exploration and appraisal activity, there should be more than an adequate inventory of physical resources available to increase supply to meet anticipated levels of demand in this time frame. Post-2030 supply may well struggle to meet demand, but an undulating plateau rather than a dramatic peak will likely unfold. Moreover, if the "peak demand" now evident in the OECD countries is a precursor of later developments in the emerging markets, world demand itself could eventually move on to a different course.
In the short term the industry is at another crossroads following the precipitous fall in demand in 2008–09 in response to the onset of the recession. The oil price has roughly halved from its peak of $147 per barrel in July 2008, OPEC has recently cut production, OPEC spare capacity has nearly tripled to 6.4 mbd, and the industry has slowed its pace of expansion. Early in 2009 IHS CERA estimated that as much as 7.5 mbd of new productive capacity could be at risk by 2014 if costs remained high and oil prices hovered just below the cost of the marginal barrel for two years. Since then the oil price has recovered strongly to around $70–$80 per barrel, and some confidence has returned. Even in these unpredictable times the industry has continued to invest and to build new productive capacity; indeed, Saudi Arabia recently brought onstream the giant Khurais field, which at plateau is expected to produce 1.2 mbd. With sustained investment, a healthy cushion of spare capacity, and slow to moderate post-recession economic growth, supply should not present major problems, at least in terms of availability, in the short term.
Of course looking further ahead, it is important to recognize that oil is a finite resource and that at some stage supply could fail to meet demand on a consistent basis. It is impossible to be precise about the timing of this event, but given the pace at which demand has increased in the past decade a pivot point may well be reached before the middle of this century. Much depends on key factors such as global economic growth, the capability of the upstream industry, costs, government policies on access and taxation, the evolution of renewable and alternative energy sources—particularly for transportation—and the effect of climate change issues on policies and regulations concerning the use of fossil fuels. However, there is time to prepare and to make rational decisions to avoid being forced into short-term approaches that may not resolve longer-term problems.
Many studies of future oil supply examine subsurface issues and focus in particular on the scale of the resource while giving limited consideration to technology, economics, and geopolitics. Though belowground factors are critical, it is aboveground factors that will dictate the ultimate shape of the supply curve.
This IHS CERA Report presents the main points in our current productive capacity outlook to 2030 and discusses the architecture of future conventional and unconventional oil supply. In order to provide a framework, the methodology and foundations of the outlook are reviewed and the results of supporting studies on decline rates and giant fields are included.
In so doing, this report addresses the debate over "peak oil." There is much emotion involved in that debate. In our view much would be gained by lowering the emotional level and instead shifting to a more objective dialogue, based on a comparative view of data, methodology, and analyses. Our hope is that this paper can contribute to such a discussion and exchange. Our further hope is that out of such a dialogue will come a deeper understanding of the world’s oil supply in the decades ahead—a question crucial to the world’s overall future.
There are many areas of overlap between IHS CERA’s view of future oil supply and other outlooks. Oil is a finite resource, and at some stage supply will begin to fall short of meeting demand on a consistent basis if there is no break in the connection between economic growth and oil demand. The basic differences in opinion appear to center on when this will happen and on what happens after the inflection point. The view that oil supply will plummet after the inflection point and oil will run out, like the gasoline in an automobile, is misleading for the layperson.
IHS CERA believes that this inflection point will herald the beginning of an undulating plateau of supply that will last for perhaps two decades before a long, slow decline sets in (see Figure 3). It represents a transition period when traditional market forces and government policy will be unable to adjust supply to meet growing demand and limits are reached. Of course the path of demand will exert a controlling influence on the future supply curve. Peak demand is an equally important concept that may well be viewed in hindsight, from the perspective of a half century from now, as the main driver of peak supply.
But one further important point: Though a peak of global oil production is not imminent, there are major hurdles aboveground to negotiate.
Methodology: Defining the Yardsticks
Let us begin with the methodology with which we approach these questions.
Productive capacity is defined as the maximum sustainable level at which liquids can be produced and delivered to market. Productive capacity estimates account for routine maintenance, but not for general operational inefficiency, temporary interruptions such as weather or labor strikes, nor for dramatic swings in political and economic factors. For example, a field may have a productive capacity of 140,000 barrels per day (bd) but in reality produce 130,000 bd on average over a year because of unforeseen maintenance issues, regulatory inspections, rig movements, and tie-ins.
At the core of IHS CERA’s methodology is recent production history, which is considered the most reliable data available on which to base a supply projection. We can measure the barrels arriving at the surface over time. Future production trends are extrapolated using a comprehensive framework of decline rates and knowledge of operational plans for individual projects and fields. Remaining reserve data are an important constraint on the future supply profiles but—given the uncertainties in reserves estimation—can be used only as a broad guideline of future supply.
Four key components of supply are included in the outlook (see Figure 1):
fields in production (FIP)
fields under development (FUD)
fields under appraisal (FUA)
yet-to-find (YTF) resources
IHS CERA has fully incorporated the data from the IHS International Field and Well Data database so that there are approximately 24,000 fields and discoveries underpinning the outlook. In addition, we have conducted detailed analysis of field production characteristics, especially decline rates, which have been incorporated at the field and project levels.
A detailed database of approximately 450 OPEC and non-OPEC FUD provides a clear insight into the immediate plans of the industry to execute new projects ranging individually up to 1.2 mbd at production plateau. YTF resources are estimated by extrapolating historical activity and success rate data and making assumptions about future levels of activity in key countries. We have recently compiled historical exploration data from the IHS International Field and Well Data database on well count, success rate, and discovery sizes for each country, which has improved the YTF analysis.
In this activity-based model we take account of project efficiency, costs, timing, hardware availability, and our detailed oil price outlook. We adopt a holistic portfolio perspective to evaluate global productive capacity. Although it is clear that some giant fields such as Mexico’s Canterell are now strongly in decline following a successful secondary production program, and many countries are past their "peak," the sum of the parts as we currently see them show that global productive capacity should be able to grow for at least the next two decades.
Why So Much Variation Among Published Outlooks?
The long and complex debate about the future of global oil supply is characterized by two overriding characteristics: the very large range of potential outcomes projected and sustained disagreement about "the answer."
Production volumes are closely related to reserves, rock physics, and investment. Publicly available data tend to be limited and of variable quality. A wide range of methodologies have been applied to the problem, from those encompassing systematic analysis and careful assumptions to less robust techniques such as Hubbert’s method, which can provide a good approximation in certain circumstances but fall down especially where government policy constrains production. Importantly, Hubbert’s approach, developed in the 1950s when technology was stagnating, also fails to account for fluctuations in demand, technology advances, and the discovery of new hydrocarbon plays. Additionally different studies are based on variable views on reserves/resources, field production performance, future exploration, technology, and commercial issues. Few have attempted to incorporate the impact of aboveground factors such as demand and geopolitics.
Some models are based on a very pessimistic view of the future, which is not borne out by scrutiny of recent trends in exploration and production. For example, frequent claims—that "half of global oil reserves have been produced," "global reserves are not being replaced on an annual basis," and "deepwater exploration is essentially exhausted"—are questionable. The recent discoveries of ten giant oil fields below a thick salt layer in the Santos Basin, Brazil, may have boosted global resources by at least 25 billion barrels. Further assertions that giant oil fields are past their prime simply are not borne out in a recent detailed study of 548 giant oil fields in the IHS CERA Private Report Giant Fields: Providing the Foundation for Oil Supply Now and in the Future? This study demonstrates these fields’ continuing strong contribution to global supply and that some 76 giant fields, representing 84 billion barrels, remain undeveloped. Fields in general and giant fields in particular still show considerable potential for reserves upgrades, as illustrated in many studies.
IHS CERA’s 2009 Supply Outlook: "Pausing for Breath"
In our most recent reference case outlook, global productive capacity is expected to average approximately 92 mbd in 2009 and to rise to 115 mbd by 2030. This is a lower rate of growth than we have projected in the past and reflects the reaction of the oil industry to recent changing market forces. This is just one version of many possible outcomes, and we use it in this report to illustrate the architecture of supply and the nature and scale of the problem. This reference case provides a view of the building blocks of future supply in terms of FIP, FUD, FUA, and YTF as well as "Others," the category of unconventional liquids that include extra heavy oil, biofuels, coal-to-liquids/gas-to-liquids, and natural gas liquids. With aggregate decline rates of around 4.5 percent per year, FIP provide a diminishing proportion of the total future capacity. But in terms of the conventional oil asset life cycle, exploration replenishes the appraisal project inventory, which feeds into sanctioned development projects and ultimately producing fields. Figure 1 is a snapshot of a very dynamic system.
This summary does not show evidence of a peak in oil productive capacity before 2030. However, it does emphasize the importance of future exploration and the role of unconventional liquids in generating growth in the future. IHS CERA believes that unconventional liquids already contribute around 14 percent of total global capacity, and we expect this share to grow to 23 percent by 2030. The contribution of exploration is emerging as one of the key uncertainties and is the subject of current IHS CERA research.
This model assumes that
The oil price stays above the cost of the marginal barrel for most of the period to 2030.
There are adequate existing and future resources to support these sustained volumes of higher capacity.
The industry can build the hardware and develop the technical capability to implement investment programs.
What Are the Challenges to Producing a Robust Outlook?
Predicting future productive capacity hinges on an in-depth understanding of a complex multicomponent system, which is driven by the interplay of both aboveground and belowground factors. It is not realistic to treat the global oil endowment as if it were simply in a tank being emptied. IHS CERA’s experience of evaluating productive capacity over two decades suggests that there are no unique answers, a point reinforced by the wide variety of published outlooks noted above.
As part of our ongoing research program IHS CERA has concentrated on a number of factors that will strongly influence future supply:
Data. The IHS CERA reference case outlook is based largely on the IHS International Field and Well Data, and North American databases, which are arguably the most comprehensive available upstream data sets available. A reliable and comprehensive database is critical to any credible projection—but the complexity of the analysis requires making some significant assumptions. IHS CERA has critically tested many of these assumptions by studying some of the key questions relating to historical exploration trends, resource replacement, and oil field performance.
But even a perfect data set would generate a range of possible outcomes in modeling because of the complexity of the problem. The debate about future supply and data has tended to focus on subsurface technical data, especially reserves data. But there is a wide range of sources related to aboveground drivers that is also crucial in assessing country-specific economic data and projections—which drive supply—as well as rig count, yard space, and service sector capability.
Reserves. To date, the analytical core of this debate appears to have hinged on knowledge of field and global reserves. Oil and gas reserves are defined as the volumes that will be commercially recovered in the future. Hydrocarbons are trapped in reservoirs underground and cannot be physically audited or inspected, so estimates are based on the evaluation of data that provide indirect evidence of the scale of the reserve base. The Society of Petroleum Engineers (SPE) has produced a detailed set of six categories of reserves and contingent resources and three categories of undiscovered prospective resources. These reserves estimates entail large degrees of uncertainty, and a great deal of experience and judgment are required in performing the calculations.
Given the complexity of the calculations there are no unique answers at the individual field or global levels, and we still do not know exactly how much has been discovered or what remains to be found, despite any claims to the contrary. Current estimates can only be considered as orders of magnitude. The questionable use of resource estimates is well illustrated by Hubbert’s (1982) approach, which suggests that a peak of production occurs when half of the global inventory of supply has been produced. This seems plausible initially, given that some 1.1 trillion barrels of oil has been produced to date and there are apparently some 1.2 trillion barrels remaining to be produced. But that is appearances. What this approach does not make clear is that this analysis is based on "proven plus probable conventional reserves" alone, which amounts to 2.3 trillion barrels. It ignores all the remaining categories of conventional and unconventional reserves and resources (including possible, contingent, and prospective reserves), defined by the SPE, which could ultimately contribute at least as much again. IHS CERA estimates that global resources could be approximately 4.8 trillion barrels, including just over 1.1 trillion barrels of cumulative production to date.
It is clear that we are dealing with a finite resource, but more consistency in reserves reporting and further systematic studies are needed, such as the United States Geological Survey (2000) study of global YTF resources, to improve the quality of the numbers. Remaining reserves data are an important constraint on the future supply analysis—but given the uncertainties this can be used only as a broad guideline. Existing resource estimates have a habit of being increased as fields are upgraded and new plays are established.
Decline rates and field performance. At the core of IHS CERA’s productive capacity model is an extrapolation of historical production data into the future. We have completed a study of over 1,000 fields to understand the characteristics of field production through the buildup, plateau, and decline phases. Central to this analysis is an attempt to estimate typical decline rates for a range of field sizes and types in different geological and geographic environments. Information from relatively mature, data-rich areas such as the North Sea and Norway suggested that decline rates were well above an alarming 10 percent on an individual field basis, so it was important to complete this study to develop a more accurate and representative picture around the world.
In the discussion there often seems to be a confusion betweendepletion and decline. All oil fields start to deplete the day production begins, but not all fields have production in decline. Oil field production only starts to decline after the plateau period of production has ended. From our 1,000 field study database only 40 percent of production comes from fields in decline, suggesting, perhaps surprisingly, that a significant proportion of all production comes from fields building up or on plateau. This striking point often seems to be lost in the discussion. This study showed that the average decline rate for fields that were actually in the decline phase was 7.5 percent, but this number falls to 6.1 percent when the numbers are production weighted. The numbers were subsequently corroborated by the IEA (2008). Importantly, the global aggregate decline rate of all fields currently in production (which includes fields building up and on plateau) works out to be around 4.5 percent. It is anticipated that aggregate decline rates might increase slowly with time and also that ultimate recovery will continue to increase medium term.
Giant fields are still the cornerstone of global production. Some 548 giant oil fields contribute 61 percent of the total; and although production from the giants has risen, that proportion has remained steady in recent years. Recent IHS CERA research on giant oil fields shows that collectively the giant fields are not in decline and that some 60 percent of their recoverable oil remains to be produced. The number of giant field discoveries has declined in recent years, but their contribution seems unlikely to plummet in the near term.
Costs and capability. The IHS CERA Upstream Capital Costs Index (UCCI) is a combination of a set of indexes used to monitor the current state of the global upstream cost environment. Set at 100 in 2000, it more than doubled by the end of 2008 (230). This means that oil companies were essentially spending twice as much to undertake the same amount of work as in 2000. By the end of September 2009 the UCCI declined to 202, putting costs back to early 2007 levels; and although oil prices recently fell back to 2004 levels, cost reductions are projected to drop only gradually over the next six months. Some service sectors, such as the deepwater rig market, will sustain a high pricing structure because of the sustained demand; others, such as jackup rig markets, have softened and may continue to do so.
One critical factor for future oil output is people. Current upstream sector demographics are such that a large proportion of experienced professionals will retire in the next ten years. The industry has acknowledged this for a number of years and has taken steps to hire and train a new generation of experts, but this may be too little too late. In the current downturn the industry is again in danger of further erosion of its skills base. The service sector in particular is under pressure from operating companies to reduce costs, and this means rationalizations of staff, which will seriously restrict the capability of the service sector in the future.
Other aboveground factors. One key driver of the future supply outlook, rarely considered, is the ability of OPEC countries to control production. In most non-OPEC countries exploitation has progressed without much constraint. This means that for many non-OPEC countries, especially those with modest reserves, production has already peaked. While non-OPEC production capacity still has the potential to grow, it always produces at the limits of its productive capability with limited flexibility. On the other hand, with its vast resource base, much of it undeveloped, OPEC has controlled investment and production, depending on market conditions. Many OPEC countries have specific policies that control the pace of exploitation for future generations. Also many national oil companies have a different approach to oil field exploitation that focuses on optimizing long-term recovery. Extrapolating the impact of current OPEC investment and policy on future supply does not support a short- to medium-term shortage of oil.
Any outlook can present only one potential version of the future. IHS CERA uses a reference case production capacity outlook to generate three scenarios for future production—Asian Phoenix, Break Point, and Global Fissures—that enable an understanding of the range of possible drivers of future supply and describe three feasible outcomes. Recent oil price volatility has further reinforced the point that the future is highly uncertain and a range of outcomes should be considered.
The Big Picture
It would be easy to interpret the following market and oil price events from 2003 through 2008 in isolation to support the belief that a peak in global supply has passed or is imminent:
oil price spike to $147 per barrel in July 2008
tight supply-demand balance of around 2.5 mbd through mid-2008
considerable decline in global production to around 83 mbd
However, these events are linked to an array of political and economic factors, including a global boom, "the rise of the emerging markets," financial market impact, and constraints on "catching-up" in developing new capacity. They do not herald the onset of a peak and at the simplest level illustrate that the market continues to act as the shock absorber of major volatility. Supply continues to respond to prices (conditioned by expectations of future demand), and simultaneously demand responds to prices.
Improved data availability and transparency could help to produce more accurate outlooks for future capacity—but even this will not provide unique, reliable answers. Subsurface data on reserve levels and decline rates are only a part of the story. Some of the major aboveground factors that will continue to affect what actually happens to output are listed below. Both their importance and the range of possible outcomes inherent in them are evident:
future course of the global economy
government policies and decisionmaking in resource-holding countries
balance and impact of the complex web of geopolitics
future course of oil prices
course of government policies that focus on controlling demand
development of renewable energy sources and climate change issues
Many projections, including those based on the methodology of Hubbert, fail to account for the impact of economics, technology, or geopolitics,while others concentrate on conventional oil alone and fail to account for the growing proportion of unconventional oil being developed and produced. One is struck by the conviction, in each period, that technology has gone "about as far as it can go."
IHS CERA tackled this issue by developing a possible range of outcomes through plausible scenarios for the future of global energy. Even this comprehensive study—completed in 2006—does not present a unique base case projection, but rather develops the three scenarios noted above—Asian Phoenix, Global Fissures, and Break Point—extending to 2030. Indeed elements of these scenarios have played out during the past three years.
The Break Point scenario, developed in 2006, envisaged that oil prices would reach $150 per barrel. It demonstrated the importance of the feedback loops. In this scenario high prices and fear of shortage have a strong price response and policy response. The results include a shift by consumers and automakers, and programs to enhance energy efficiency and accelerate growth of alternative fuels, and oil loses its monopoly on transportation.
Global Fissures envisions a deep recession. A widespread political backlash against free trade and globalization, combined with global trade and political disputes, lowers economic growth and weakens energy prices. One of the triggers is a hard landing of the US economy, owing to the overhang of debt in housing and other sectors. Global Fissures reflects the current global climate most closely.
Looking ahead, we can see that the upstream industry faces many challenges. There is little doubt that the existing and possible future resource base can support growth in capacity through 2030. There is no shortage of new projects or exploration potential to replenish the hopper. Exploration and field upgrades have tended to replace global production in recent years. Exploration is not yet in terminal decline, and while recently some 12 billion barrels of oil has been discovered annually, the five-year moving average is actually growing (see Figure 2).
The longer-term problem lies not belowground, but in obtaining the investment and resources that the industry will need to grow supply significantly from current levels. Both OPEC and non-OPEC countries have a strong current inventory of some 450 projects under development. The recent fall in oil prices has precipitated a slowdown in the rate at which projects are being sanctioned and developed—but this temporary situation will ease when the global economy starts to recover. The projected medium-term slowdown in the rate of supply growth is a simple function of economics rather than evidence of an imminent peak.
Yet there are a number of trends that cause concern. Non-OPEC growth has been worryingly anemic for five years, driven largely by slowing growth of productive capacity in Russia. Non-OPEC may well struggle to regain the annual growth levels greatly exceeding 500,000 bd that were common before 2004. OPEC countries will be a key element of future growth, but prolonged periods of low oil prices (below $60 per barrel) and abundant spare capacity of around 6.5 mbd might well start to inhibit long-term supply growth. But just over the horizon a period of strong economic growth could quickly reverse this trend.
However, structural changes currently occurring in the service sector in response to falling costs will pose a threat to future supply expansion. After nearly a decade of strong growth in response to increasing demand, some service sector companies are downsizing and restructuring, and this will affect the ability of the service sector to help bring on new supply at an appropriate pace when demand starts to recover.
While the current economic situation has driven a reduction in exploration and production investment, it has also coincidentally provided a supply cushion that will take some time to work its way back into the system. Companies continue to build new productive capacity, albeit at a slower rate than one year ago. Collectively this will provide a short-term cushion until the global economy starts to pick up again from 2010 onward. One can well envisage a scenario half a decade or so from now in which a period of strong demand growth again leads to a period of tight supply and higher prices as investment and capacity growth fail to keep up.
But this should not be confused with the inflection point (see Figure 3). Ultimately there will be an inflection point when sustained growth of productive capacity will cease. As already noted, one fundamental difference is the view of when it occurs—is it imminent or two decades or more away? The other difference is on the question of what happens after the inflection point. The idea that oil supply will collapse after the inflection point and that oil will run out of the "tank in the ground" confuses the public. In our view this inflection point will inaugurate a new era—the beginning of an undulating plateau of supply. That, in turn, will last for another two decades or so, before a long, slow decline sets in. Would that be in 2050 or 2060 or even 2070? Whenever, it would take us into still a third era—the start of a transition period when traditional market forces and government policy will be unable to adjust supply to meet growing demand and the real limits are reached.
But much will happen before then that will affect demand—from changes in the automobile engine and the electric battery to changes in demographics and values. That is why the concept of "peak demand" is so important. Ironically, it may come be viewed in retrospect as the main driver of peak supply. In that case what happens aboveground will have set the tempo for what happens belowground.
