From Oil & Gas Journal

March 2000

By C.J. Campbell

The fundamental driver of the 20th century's economic prosperity has been an abundant supply of cheap oil. At first, it came largely from the US as it opened up its extensive territories with dynamic capitalism and technological prowess. But its discovery rate peaked around 1930 and inevitably led to a corresponding peak in production about 40 years later. The focus of supply shifted to the Middle East, as its resources were tapped by the international companies. Those companies, however, soon lost their control in a series of expropriations as the host governments sought a greater share of the proceeds. In 1973, some Middle East governments used their control of oil as a weapon in their conflict with Israel, giving rise to the first oil shock that rocked the world.

The international companies had, however, largely anticipated these pressures, and before the shock had successfully diversified their supply with new productive provinces in Alaska, the North Sea, Africa, and elsewhere. These deposits were more difficult and costly to exploit, but production was rapidly stepped up when control of the traditional sources was lost. In part, that was made possible by great technological advances in everything from seismic surveys to drilling. Geochemistry and better geological understanding made it possible to identify the productive trends, once the essential data had been gathered.

The industry found and produced the expensive and difficult oil from the new provinces at the maximum rate possible, leaving the control of the abundant, cheap, and easy oil in the hands of the Middle East OPEC countries. The latter were accordingly forced into a swing role, making up the difference between world demand and what the other countries could produce. It should have surprised no one that such an arrangement led to price volatility.

Depletion concerns But these new provinces faced the same depletion pattern as had already been demonstrated in the US. The larger fields, which were found and exploited first, gave a natural discovery peak. Advances in technology and operating efficiency also reduced the time lag from discovery to the corresponding production peaks. Whereas it took the US 40 years, the North Sea, now at its peak, did it in just 26.

As discovery in accessible areas dwindled to about one fourth of consumption, the industry, which fully appreciated this obvious link between discovery and production, turned its attention to the last frontier, namely the deep waters.

The deepwater theater is also subject to depletion, with an even shorter time lag between the peaks of discovery and production. Although much of the world's oceans is deep, only a few areas have the essential geology, giving a potential of not more than about 85 billion bbl-enough to supply the world for less than 4 years, at current rates of consumption. It is no panacea. Price, supply crises A combination of circumstances led to a dramatic fall in the price of oil in 1998. They included unseasonably warm weather; an Asian recession that reduced the demand for swing Middle East production; the collapse of the Russian ruble, encouraging exports; and further turns in the UN-Iraq imbroglio.

The market itself, which now included hedge funds and derivative merchants, had no alternative but to overreact because of its transparent short-term nature. Majors, plainly seeing that exploration could not underpin their future, took the opportunity of the price crisis to merge, successfully concealing their real predicament from the stock market. Budgets were slashed, and a climate of uncertainty led to an improvident draw on stocks. Everyone hung on the pronouncements of OPEC, imagining that it held the key.

Norway and Mexico offered to cut production to help support price. The OPEC countries themselves did everything possible to foster the notion that they could flood the world with cheap oil at the flick of a switch. It was a strategy aimed at inhibiting investments in gas, nonconventional oil, renewable energy, or energy conservation that OPEC feared might undermine the market for their oil, on which they utterly depend.

But it was a short-lived crisis, and before long the underlying resource and depletion pressures manifested themselves. Now, oil prices have rebounded with a staggering 300% increase in 12 months. Many of the famous oil analysts who were predicting that oil prices would stay low forever, are changing their chameleon skins as they watch prices soar through $30/bbl and break the chartists' barriers. With bated breath, they hang on the next word from OPEC. The US Secretary of Energy travels the world speaking of diversity of supply as he talks in vain to countries with little to offer in the face of depletion.

Norway's role as the world's second largest exporter is critical, but it transpires that not a single well was closed by government edict. It is easy for the Norwegians to support price as they watch their old giant fields fall off plateau despite every heroic effort. Mexico has now confessed to the previous exaggeration of its reserves, which in 1999 fell, following an external audit, from 49 billion bbl to a more-realistic 28 billion bbl. Meanwhile, it is forced to undertake a mammoth nitrogen injection scheme to try to pump up the aging Cantarell fields. It does not sound as if the Mexicans have much option but to watch their production begin to fall.

The Middle East fields too are getting old, and in some cases, very old. Development drilling has continued unabated despite the fall in production. Venezuela's new production comes largely from infill drilling in old heavy oil fields, which is dependent on the amount of effort and investment. It does not sound as if it has many shut-in wells either. Its oil officials now speak of reduced capacity.

Likely scenario Logic suggests a scenario like this:

OPEC makes some conciliatory noises about raising quotas in response to US pressure, wishing to maintain the illusion that its members can meet demand at will. Norway and Mexico continue to support OPEC within the framework of such conciliatory words, making a virtue of necessity. The market takes the hint and marks down the price of oil in an action that feeds on itself as the new flavor of the month permeates the ranks of speculators, hedge funds, and derivative specialists searching for a quick buck. Refiners hold back from filling their tanks. Prices collapse to the low $20s, even perhaps plummeting briefly into the teens. People relax in the belief that the wolf has headed back into the forest. The famous flat-earth economists again cheer that market forces reign supreme. But then a few weeks later, people begin to notice that fewer tankers are arriving. Norway says that storms were responsible; Venezuela speaks of floods; Mexico claims restructuring; Saddam says he needs a spare part; and King Fahd leads a delegation of puzzled senators into the desert to show that all the wells are fully open.

The penny finally drops that there is no instant spare capacity in the sense of shut-in wells. The men at their screens start marking up prices. A new upward momentum drives prices through the $40 barrier. When Air Force One makes a new panic tour to Norway, Mexico, and the Middle East, it meets ashen-faced oil officials saying that they have been working night and day to meet their quotas but are unable to do so. The world, including OPEC, gradually appreciates that it faces a losing battle in trying to offset the depletion of the large, old, low-cost fields.

Middle East options Of course, the Middle East countries can raise their production, because depletion rates there are so low, but it will be a long haul to bring in the ever-smaller fields, which are all that remain, and exploit small extensions and secondary reservoirs in known fields. It is not a matter of simply opening a valve.

The Middle East's share of the world's supply of conventional oil was 38% in 1973 at the time of the first oil shock but had fallen to 18% by 1985 as the new provinces flooded the world with flush production from giant fields; it is now about 30%. Unlike in the 1970s, this time, it is set to continue to rise, as there are no new major provinces in sight. That share will likely reach 35% by 2002 and 50% by 2009. By then, the Middle East, too, will be close to its depletion midpoint, and unable to sustain production much longer, irrespective of investment or desire.

It will be a hot summer. Strident politicians will accuse the oil companies or the Muslims of gouging the consumer, their minds having been further concentrated by a related collapse of a grossly overheated stock market. No doubt there will be calls to send in the Marines. But it is a US election year, and the presidential candidates will relish the agony of the dying days of the old administration. Democratic politicians cannot in practice plan for the future, but they can certainly win votes by reacting to crises. So the hope is that the new president will look reality in the face and tell the people what he saw.

If he does so, he will explain that we are not about to run out of oil but that conventional oil will peak around 2005 and all oil 5 years later. Once the people realize that they are not being gouged by anyone, they will face up to their predicament with courage and fortitude. They will be surprised at the number of solutions, some improving the quality of life, but finding oil that is not there to be found will not be one of them.

The Author C.J. Campbell is a consultant to industry and governments, specializing in oil resource assessments. He is a partner with Petroplan Inc., a member of the PetroData Group. Campbell is author of a book, The Coming Oil Crisis, published in 1997 by Multi-Science Publishing Co., England. He began work in the oil industry in 1958 as an exploration geologist in Latin America and Australia, working first for Texaco Inc. and later for British Petroleum Co. PLC. In 1967, he joined Amoco Corp. in New York as a regional new ventures geologist, then became general manager for Shenandoah Oil Corp. in London in 1972 in a joint venture with Saga Petroleum AS. Campbell was named exploration manager for Amoco in 1980 and executive vice-president for Petrofina SA in 1985, both in Norway. He holds a PhD in geology from Oxford University.